- Jo Earlam
- September 5, 2022
- 9:03 am
- 10 min read
Managed Money caught the wrong side of the Cotton market
Prices change when events are different from what the market has expected them to be.
CTZ22 103.21 (-5.00)
CTH23 100.14 (-5.00)
CTK23 97.79 (-4.58)
CTN23 94.45 (-3.32)
CTZ23 81.92 (-2.19)
Zhengzhou CF301 – 15,030 (-590)
Cotlook “A” Index – 131.60 (+1.00) – From the 1st September 2022
Daily volume – 36,780
AWP – 104.48
Open interest – 212,431
Certificated stock – 4,552
Z22/H23 spread – (+3.07)
Z22/Z23 spread – (+21.29)
December Options Expiry – 11th November 2022
December 1st Notice Day – 23rd November 2022
Introduction
– Cotton finished the week with 2 limit down moves in front of a USA Labor day holiday weekend after breaking below the 111.01 low dating back to 19th August. Prices traded in yet another very wide trading range of 1632 points between 103.21 and 118.53, before closing 1447 points lower than the previous Friday close.
– Futures volume was impressive, averaging 25,677 futures daily and picked up significantly when prices broke below 111.01, in Thursday’s trade. The average intraday move of 414 points this week is reason enough for why implied at the money volatility in the front month Z22 contract remains very high at just under 42%!
– Below is a Cotton continuation chart dating back to 1970. The high to low this century is 28.20 to 227.00. Emotions run high when we see moves in Cotton as we have witnessed over the last 12 months but a look at the chart below is a factual reminder that despite everything Cotton will revert back to its “mean” and prices in the 100’s are seldom seen for extended periods.
– Few people agree with EAP on the suggestion we will be back below 80c by seasons end but it is what our work suggests and what our computer model predicts!
– We would add that there are 14 futures contracts quoted in Cotton, going all the way out to May 2025. May 2025 closed on Friday at 75.19 being more than 28c/lb under the spot Z22 contract. Even Z23 at 81.92 with an open interest of just under 20k contracts tells even the most bullish out there the fact that future prices of Cotton are much cheaper than the spot price is currently quoted!
– Back in the 1864/65 repeat 1864/65 season the Cotton price reached 186c/lb before collapsing to just 18c/lb just under 2 years later with the 1865/66 season proving as usual to be an inverse season which has always happened following a move into the 100’s
– The weekly COT report saw Managed Money adding to their now rather long and losing position, having purchased a net 3,115 contracts as of last Tuesday (when Z22 closed at 112.32) to take their long to 53,893 contracts. Between MM, OR and NR their overall net long is 61,030 contracts. MM have bought just over 20k contracts since the August WASDE and the average close of Z22 over that time is about 113c/lb meaning 20k of their long is losing 10c/lb!
– In the weekend technical analysis report it was suggested Cotton prices are going immediately higher and is a point we have to disagree with. The fact that funds are long and wrong is probably the single largest reason we have for why this technical viewpoint is likely to be altered in the days ahead.
– Hedge funds, as we have reminded readers of these pages in the past, are trend followers and not trend setters. With prices settling the week below the 200 day moving average at 105.25, and noting funds will often act on a break above or below this indicator, we strongly suspect a large proportion of this position will be liquidated in the days ahead.
– As normal, we will be reminded by many traders of the extremely tight supply side of the USA Cotton balance sheet and rightly so! However, fundamentals take a back seat when the money takes charge and as we saw back in July. Back then prices overshot to the downside as the MM got out, before bouncing back.
– At the same time, the end user buying that was absent at 95c/lb before publication of the highly bullish August WASDE, will also need to return. That part of the picture we are less sure about!
– However, we know that with prices dropping so hard the current 0-50% capacity of mills in India, Bangladesh, Vietnam and Turkey will eventually improve. Circa 85% of raw cotton is produced in the Northern hemisphere and places like Turkey and India in particular have plenty of their own local new crop Cotton available in the coming weeks.
– Mills who can access local Cotton will be buying this 1st rather than looking to expensive high basis Cotton from elsewhere!
– If pushed to make a prediction, we believe that prices will continue to struggle and suggest that we can go as low as 90c/lb on this move, whereupon end user buying will likely resurface, and/or Z22 “on call” fixations will occur. By then, MM will have got out of what they need to and guesstimate a 88c/lb to possibly 108c/lb trading range into Z22 expiry.
– We have long bleated on that we see the 22/23 season as having a similar price action to the 11/12 season and maintain that viewpoint.
– Charts of the Z22 season to date and what happened in 11/12 are shown below. Back in 11/12 we had a biblical drought in Texas, a USA crop 2.5mb lower than the season before, nearly 80% USA export commitments by Z11 expiry and India banned exports in March 2012.
– The supply side of the equation in 11/12 was very bullish but demand was not and the CRB Index more than halved! N12 closed on the 31st May 2012 at 71.35 and was the seasonal low being 40c/lb lower than it was trading at the previous September! Can history repeat or at least rhyme somewhat…we believe so!
– Merchant basis levels remain stubbornly high and whilst some Cotton may be selling, we doubt that these levels can last for an extended period. The freight delays of the past are fading fast with many of our own customers now receiving what was once heavily delayed cotton.
– The Baltic Dry Index is at decade lows and container freight rates are getting lower. We believe this has to eventually translate into a cheaper basis for new crop foreign growths as merchants search for sales into calendar year end.
– the market has shown its hand last week and EAP believe that any rallies in the Cotton market, up to the 200 day moving average at 105.25 should be sold. We would be surprised to see Z22 reach the 120’s again this season and longer term, EAP remain of the belief that the 22/23 season will prove to be an inverted one, with the final low at the end of the season and scale up selling into any strength over the coming days will likely prove to be prudent.
– With prices dropping, we can also expect the risk of defaults to occur. High priced Cotton that is on the water will look extremely expensive right now! If merchants have discrepant L/C’s to less than A1 mills, then one can expect defaults and Cotton that was once thought to be sold will be looking for a new home!
Conclusion
The market has shown its hand last week and EAP believe that any rallies in the Cotton market, up to the 200 day moving average at 105.25 should be sold. We would be surprised to see Z22 reach the 120’s again this season and longer term, EAP remain of the belief that the 22/23 season will prove to be an inverted one, with the final low at the end of the season and scale up selling into any strength over the coming days will likely prove to be prudent.
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Written by:
Jo Earlam
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