How speculators were humbled in the global cotton market last week

Last week, cotton futures on the Intercontinental Exchange (ICE), New York, plunged by over 25 per cent to drop to a nine-month low currently. Cotton prices, which had surged to an 11-year high of 158.40 US cents a pound (₹98,500 per candy of  356 kg), slumped by a record of over 30 cents on a single day on June 24 (Friday).

Traders’ reason for cotton price plunging is the trend in other commodities, particularly metals. Many commodities have slid to multi-months low due to demand slowdown and fears of a recession in the wake of interest rate hikes by central banks. But those who have watched the cotton market since December point to a different factor for the slump that has caught many by surprise.

Podcast | Why are cotton prices falling, and how does the market look till year-end?  Podcast | Why are cotton prices falling, and how does the market look till year-end?  

First Notice Day

Those in the know point to “unfixed on-call sales” for the plunge, particularly on June 24, the First Notice Day when buyers who had purchased futures contracts may be required to take delivery. 

The feature of the “unfixed on-call sales” is that a buyer or speculator purchases cotton from a seller without fixing the price. When the buyer and seller enter into an “on call” contract, a futures contract would normally be sold to hedge the transaction. Later, when the seller and buyer agree on the price, the short futures position would be bought back.

During the current season (October 2021-September 2022), some of the buyers had purchased cotton in November hoping that they could fix the prices in January. But since prices were ruling high, they went on dragging their feet on fixing the prices. 

Beating retreat

This resulted in a very high level of “unfixed on-call sales”, leading to short covering in the range of 6.5 million US bales (8 million bales of 170 kg) in international markets in May this year. The normal volume for such sales is 2.8 million US bales. In turn, it also pushed up prices that did not reflect the fundamentals. 

“It was a game between speculators, on the one side, and hedgers and sellers, on the other, over unfixed on-call sales. Speculators had taken huge positions without any reason, expecting to catch hedgers by surprise. They thought sellers will not have certified stocks to deliver. But when hedgers mopped up certified stocks, they had no alternative but to retreat,” said Anand Poppat, a Rajkot-based trader in cotton, yarn and cotton waste. 

As a result, cotton prices which were ruling at 143.15 cents (₹108,425 a candy) for the July contract on June 22, plunged to 103.84 (₹64,700) on June 24. 

Earlier instances

“Looking at the old crop contracts, as of May 27, 2022, the  July 2022 contracts show an excess of unfixed call sales over purchases that implies 10.7 futures bought back for every one sold when the related on-call contracts are finalised. That’s large..,” said Texas A&M Agrilife Extension, a unit of the Texas A&M University. 

“We have seen this before in the last few years, e.g., during June of 2013.  There was a lot of thinking that on call buying would support or lift cotton prices during 2014 and 2017, but the historically large discrepancies between unfixed call sales and purchases appeared to resolve themselves without explosive rallies,” Texas A&M Agrilife Extension said.

Similar situations arose in 2016, 2018 and 2019 but they were resolved without much volatility. In this situation that cropped this year, there was always the danger of prices going out of control on June 24 if hedgers had not got the certified stocks ready. 

Caught by surprise 

It would have been similar to the one witnessed in the nickel market when a Chinese trader went short and was caught blinking not knowing what to do. 

“Speculators have been caught by surprise and affected badly by these developments. Not only on ICE, even on MCX  a few speculators could have taken a hit,” said a spinning industry official, who did not wish to be identified.

When cotton prices had galloped to around ₹1,00,00 a candy in May, the US Department of Agriculture (USDA) and International Cotton Advisory Council (ICAC) had expressed surprise. 

‘Exuberant rally’

The USDA in its “World Market and Trade Report” said, “prices on the Intercontinental Exchange have witnessed an exuberant rally” in a subtle reference to price surge. 

The ICAC, an association of cotton producing, consuming and trading countries, said “it is difficult to identify a concrete reason for this price increase as fundamental supply and demand principles seem to be well balanced”.

Basically, traders said, the fall in cotton prices was due to the humbling of speculators. Even as cotton prices surged and ruled firm, those who had been watching the unfixed on-call sales had said the natural fibre would sooner or later drop to levels matching the fundamentals.

“Even now, there is a lurking suspicion that prices may have been dragged by some speculators who could buy cotton cheaper and then try to driven prices higher,” said Poppat. 

On Monday, ICE October contracts ended at 106.67 cents (₹66,460 a candy) and December at 98.87 cents (₹61,600).

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