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Hedge fund shorts leave softs 'collectively vulnerable' to a rally

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The extent of selling by hedge funds in soft commodities makes the complex "collectively vulnerable" to a price spike, sector specialist Judith Ganes-Chase said, while naming cotton as her best bet.

Ms Ganes-Chase, of J Ganes Consulting, said that although supply and demand fundamentals for the key soft commodities, such as cocoa, coffee and sugar, "indeed point to a period of oversupply", this has already been reflected in prices.

"The markets should have already priced in much of this bearishness on the decline in values to date," she said.

New York-traded arabica coffee futures last month hit their lowest in 15 months, and raw sugar futures a 16-month low.

New York cocoa futures remain close to near-10-year lows reached in April, while cotton late in June hit a nine-month bottom.

'Collectively vulnerable'

The declines have been fuelled by a build-up by hedge funds of a record net short position - the extent to which short holdings, which profit when values fall, exceed long bets, which benefit when prices gain.

This reached 170,590 lots in the four contracts as of last week, compared with a net long of some 230,000 contracts at the start of 2017.

However, this means that "markets remain collectively vulnerable to increased volatility should conditions suddenly turn and force a short-covering rally", Ms Ganes-Chase said.

"The weather would need to stay favourable and the dollar would need to remain strong to justify prices remaining under extreme pressure going forward."

'Favoured pick'

Nonetheless, Ms Gane-Chase said that her top call for a price revival among softs was cotton – the one of the four major soft commodities in which hedge funds retain a net long position although, at 26,410 contracts, it is well below levels above 100,000 lots as of two months before.

"My favoured pick for a price rally is cotton," she said, raising poor growing weather, or the release of US harvest pressure later in the year, as potential catalysts for higher values.

Prices would need "needs to rally towards year end to assure sufficient cotton planting in spring 2018.

"This seasonal play certainly worked well this past year and could repeat itself."

Front-month cotton futures soared more than 50% from a January low to a May high.

'Good coffee cushion'

By contrast, Ms Ganes-Chase curbed expectations for a recovery in coffee prices, given strong inventories in consuming countries, with US stocks at 7.114m bags in May, their highest in 23 years.

"There has been no respite in the build-up of coffee warehouse stocks in the US with inventory levels sufficient to provide a good cushion against any minor supply gaps for the balance of this season.

"Bull markets in coffee simply don't occur when consumer stocks are plentiful, absent a frost in Brazil or other weather calamity."

By Mike Verdin

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