Market comments – November 3, 2022

• November 03, 2022

As pointed out last week, speculators are often able to push the market around between delivery periods, but the upcoming Dec notice period serves as reality check, where cash and futures prices converge.

At 70 cents December was simply out of line when compared to the cash market and this set the stage for this powerful bear market rally. When speculators started to cover shorts on Tuesday, it was like ten elephants trying to squeeze through a three-foot door.

First futures moved limit up, then synthetic options moved to double limit up, which prompted the exchange to halt options trading. The last time that happened was in October 2010! The synthetic close for December was put at 79.19 cents on Tuesday, or about 9 cents above the previous day’s low!

This kind of price action was enough to scare any remaining shorts, triggering panic-like short covering and some opportunistic new momentum buying as well, which locked the market limit up again on Wednesday and Thursday. Fortunately the market didn’t lock up right away, which allowed for large volumes to be traded. There is nothing worse than being trapped in an illiquid market.

The last two sessions saw 144k futures and nearly 49k options changing hands, which should have allowed for anyone that needed to get out to do so. However, we were a bit surprised that open interest didn’t drop more than 3.7k contracts overall, and 6.8k in December, during Tuesday’s and Wednesday’s limit up moves. That suggests that only some of the fuel of this rally has been burned so far.

The latest available CFTC spec/hedge report for the week of October 19-25, during which December traded between 83.69 to 75.73 cents, showed that speculators were the driving force, adding a large amount of new shorts, while the trade was still a buyer into weakness. Speculators sold 0.95 million bales to increase their net short to 1.32 million bales, which is 12.77 million bales less than what we had in October 2021, when specs were sitting on a 11.45 million net long position.

The trade continued to be a steady buyer last week, cutting its net short by 0.94 to just 5.18 million bales, while index funds remained the only net long at 6.45 million bales.

Not only did speculators increase their outright short position to 5.8 million bales as of last week, but they have also done a lot of bear-spreading, which is why open interest rose to its highest level since February. In other words, speculators have dug themselves into a big hole in the December contract and are now trying to scramble out of hit.

US export sales added support this morning, as they came in at a stronger than expected 204,200 running bales of Upland and Pima cotton for both marketing years, with China being the prominent buyer with 122k running bales. In total there were 14 markets buying, while shipments of 119,100 RB went to 18 destinations. China’s strong showing was apparently related to a large mill buying for quota reasons.

Total commitments for the current season are now at 8.85 million statistical bales, whereof 2.75 million have so far been exported. Last year we had 9.0 million statistical bales in sales and 2.2 million bales shipped.

So where do we go from here? We see this as a short-covering rally in a bear market, as specs shorts have overplayed their hand and are now forced to cover. Technically this move has momentum, as we broke above a two-month downtrend line and have closed limit up for three consecutive sessions.

It is difficult to gauge when this rocket will run out of fuel, as it depends on how much more these spec shorts need to cover. Although a lot of volume has traded in the last two sessions, the small drop in open interest suggests that there might be more short covering to do. Some of it will be done via spreads, which is why December is pulling away from the rest of the board.

However, despite this steep advance, or perhaps because of it, most markets remain dead and keep complaining about too much inventory. The Fed just added insult to injury, by raising rates another 75 basis points, which will further weaken the economy. With central banks hiking rates all over the globe, it doesn’t bode well for discretionary spending.

While the bulls have some fun with this rally, we don’t believe it will last, since demand is still dismal and there is no reason to believe that this will change anytime soon. Global mill use is grossly overstated by the USDA and needs to be adjusted by millions more in upcoming reports, which will give the statistics a bearish look.

We expect the market to transition into a sideways range, as selling pressure from speculators is gone, since they won’t short the market again anytime soon after this debacle. There isn’t much natural selling at this point, but this will change once supplies increase. Rather than expecting much selling pressure, we will likely see the market ease off due to a vacuum of buying once the short-covering is over. 

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