Market Comments – January 29, 2015

NY futures regained their footing this week, as March rallied 181 points to close at 59.57 cents.

Continued strong demand for US cotton has lifted the futures market to a two-week high, with March closing in on the 60 cents level. From a technical perspective the market has maneuvered itself into an interesting position, with the 40- and 50-day moving averages looming less than half a cent above today’s close and with the weekly continuation chart about to break out of a downtrend channel dating back to last summer. Given the large outright spec short position it may therefore only be a matter of time until some major buy stops get triggered!

When looked at from a global balance sheet perspective it is difficult to put a positive spin on the cotton market, but the story is a lot more complex than that! China holds around 58 percent of the massive global stockpile of 108.6 million bales, but the price plateau in China is some 35 cents higher than in the rest of the world. Given this large price differential, China is not likely to offer any of its cotton to the ROW – quite to the contrary! China is expected to remain a net importer in the foreseeable future, albeit at a slower pace than in recent years.

Although ending stocks in the ROW have gone up this season, the stock-to-use ratio of 60 percent is still well within its 5-year range of between 52.2 and 64.7 percent. Considering how tight stocks were at the end of the last two seasons, the extra 6.5 million bales in ROW inventory was a welcome addition that should theoretically prevent another price squeeze going into this spring and summer. However, once again the story isn't that simple!

When we look at the top three exporters that currently dominate the A-index, the US has already committed a large percentage of its potential exports, whereas West Africa is probably somewhere near the halfway mark (considering the long position in merchant hands) and India is still sitting on most of its exportable surplus.

Mills have shown a strong preference for machine-picked high grades this season, which is why the US has been able to capture so much more business than its competitors. The fact that other machine-picked origins like Brazil and Australia are looking at much smaller crops has also contributed to the strong showing of US exports.

Today’s US export sales report topped all expectations with 571’900 running bales for Upland and Pima combined. China and Vietnam were once again the top buyers with a combined 352’500 running bales. Total commitments for the season have now risen to 9.4 million statistical bales, of which 3.4 million bales have so far been shipped. We have no doubt that the USDA will have to make an adjustment to its current export estimate of 10.0 million bales, possibly by as much as a million bales.

By selling over 1.5 million bales over the last three weeks, the US has tightened its statistical position to a point at which rationing via higher prices becomes likely. Export and domestic commitments already amount to around 13.2 million bales, which leaves only some 4.8 million bales of Upland and 0.5 million bales of Pima available until new crop arrives eight months from now. Of that, domestic mills will need at least 1.0 million bales between August and October to tie them over to new crop.

Paradoxically, many mills will continue to chase US cotton, since they may not like the idea of switching over to another, non machine-picked origin, midway through the season. They may therefore abandon their hand-to-mouth buying strategy in the case of US cotton and bid for remaining high-grade supplies all the way out to October.

If that’s the case, the US market could take on a life of its own and this in turn would have bullish implications for the NY futures market. According to the latest classing report the amount of tenderable qualities reached 69.1 percent this season. Total supply of Upland cotton, including beginning stocks, amounts to roughly 18.0 million statistical bales, which would give us around 12.4 million bales of tenderable qualities.

Considering that total commitments are already at 13.2 million statistical bales, it doesn’t take a lot of imagination to conclude that tenderable grades might soon be in short supply, if they aren't already. Granted, not all of these 13.2 million bales in commitments consist of deliverable qualities, but a large percentage does!

Furthermore, with the AWP set at 44.99 cents for the coming week (vs. 45.59 cents this week), there is little incentive to redeem or “pop” the six million bales that remain in the subsidy program, which only prolongs the existing tightness in the cash market. Growers have been selling into strength in NY futures to lock in a 1400+ spread to the AWP, which may explain why the market hasn’t reacted more positively to the recent export sales reports.

Only a jump in the West African and Indian CIF quotes, which are used to calculate the AWP, would free up a big enough amount of loan cotton to potentially alleviate the basis squeeze in the US market, but that may not happen soon enough for some of the desperate shorts out there.

So where do we go from here? The latest CFTC report showed a relatively large open interest in futures and options of 20.1 million bales. Speculators, driven by negative developments on the macro front, have been particularly aggressive on the short side recently and as a result they currently own 8.3 million bales in outright short positions, along with 5.8 million in outright longs.

We are not sure that these spec shorts, as well as some trade shorts, are fully aware of the fact that only US cotton can be tendered against the NY futures contract and that tenderable grades may already be in short supply. In other words, neither the abundant cotton stocks in China or India, nor all the negative talk about the world economy will do these shorts any good once it is time to lay the cards on the table. Given the large increase in open interest in recent weeks this looks like a short squeeze in the making and we therefore prefer the long side in current crop futures.