Funds have a cotton field day

Funds have a cotton field day


Grains
As of July 23, non-commercials made up a staggering 44pc of positions held on the Intercontinental Exchange number two cotton futures - the largest proportion on record.

As of July 23, non-commercials made up a staggering 44pc of positions held on the Intercontinental Exchange number two cotton futures - the largest proportion on record.

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On an aggregated basis across major agricultural futures markets, non-commercials make up 38-39 per cent of total positions, or open trades, in the market.

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Funds, risk-takers, speculators, non-commercials - whatever you want to call them - I'm talking about the short-term money which participates in almost every financial market.

Their shape and size differs dramatically, ranging from international hedge funds to individuals. But there is no doubting their considerable influence. The reason for investment can vary too, with some looking to protect against broader inflation, while others are in the pursuit of cold, hard profits.

On an aggregated basis across major agricultural futures markets, non-commercials (an industry term often used to define speculators) make up 38 to 39 per cent of total positions, or open trades, in the market.

This makes them the single-largest body of market participants. By comparison, commercials - consisting of producers, processors, merchants and end users - make up a marginally lower 36pc to 37pc of total positions. The remainder is made up of undisclosed and index traders.

In an efficient market, these speculators play a constructive role in ensuring adequate market liquidity. Additional liquidity helps the market reflect value, both timely and effectively. However, they can also exacerbate market movements, drive volatility and can see markets over (or under) shoot fair market value.

So what does this have anything to do with cotton? Well, as of July 23, non-commercials made up a staggering 44pc of positions held on Intercontinental Exchange number two cotton futures - the largest proportion on record.

Not only are these participants amassing their interest in cotton, but they're also extremely bearish - currently holding the largest number of bearish bets since records began in 2006.

The bearish sentiment stems from poor seasonal US export demand coupled with a swelling 22 to 23 million bale US cotton crop and slowing global demand growth. As the ICE number two price sunk below US60 cents a pound, these non-commercials benefited.

Take last season for example, ICE number two prices in June 2018 peaked at US95c/lb after rising 26pc over three months. During the same period, non-commercials' bullish positions increased 74pc.

In 2017, again the nearby contract was driven up to above US80c/lb - a three year high at the time - assisted by record speculative buying at the time. It's worth noting that the initial triggers behind these moves are mostly fundamentals, but it's the actions of speculators which exaggerate them.

We know non-commercials hold a dominant share of influence over ICE number 2 cotton, and have an overwhelming bearish sentiment - so what if this sentiment begins to shift? In our view, the outcome could be explosive.

Sentiment can shift in an instant - a forecast, a market release or a simple tweet - enough to drive investors to buy out of their positions en masse and take profits, also known as "short covering".

Don't forget that many of these trades will have been placed by computers, robots and algorithms, so when the horse bolts, so does the herd. And when short covering occurs, the result can be a staggering price surge.

So the question remains as to what could trigger this short covering which spooks the herd? An incoming US hurricane perhaps? Or an unexpected shift in trade relations? How about a Trump tweet? Each could be enough to ignite a sentiment shift which could to set off some mid-2019 price fireworks.

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