Market Comments – May 14, 2015

NY futures found support this week, as July gained 100 points to close at 65.53 cents, while December advanced 107 points to close at 66.50 cents.

The much-anticipated USDA supply/demand report failed to inject new life into the market, apart from an initial kneejerk reaction to the downside. Although most market participants seemed to interpret the report as mildly bearish, probably due to the potential for a high-yielding US crop coupled with lower Chinese imports, we actually perceive the numbers as being slightly friendly.

Last week we talked about the important relationship between the ROW (rest of the world) production surplus and Chinese imports, which in our opinion is still the main driver behind international prices. According to the USDA, the ROW is going to produce a surplus of just 5.0 million bales in 2015/16, while China is expected to import 6.0 million bales. This would result in ROW stocks dropping by about a million bales to 44.0 million bales during the course of next season.

We believe that most traders would agree that ROW inventories are currently quite tight, with the exception of India perhaps. Therefore, since these USDA numbers imply that ROW stocks might get even tighter next season, the market should remain well supported near current levels.

Some commentators seem to be fixated on a larger than expected US crop and a further slide in Chinese imports. However, while both of these developments are important, they need to be seen in a broader context of global supply and demand. For example, we have seen a rather dramatic decline in the ROW production surplus over the last four seasons, from 27.4 million bales in 2011/12 to 16.9 million, 13.1 million and 12.8 million bales in the following three years. As already mentioned, the USDA expects this trend to continue, with the ROW production surplus to be cut to just 5.0 million bales in 2015/16.

The main reason international prices have not fallen until the current season, despite these large ROW surpluses, is that China has been willing to absorb them year after year. In 2011/12 China imported 24.5 million bales, followed by 20.3 million in 2012/13 and 14.1 million bales last year. It was not until this season that China didn’t absorb the entire ROW production surplus, with its imports estimated at just 7.7 million bales compared to a 12.8 million bale ROW surplus. The resulting 5 million bales increase in ROW ending stocks is the primary reason why international prices have dropped by nearly 30 percent since last year.

With the ROW surplus dwindling, there is less of a need for Chinese imports. The persistently high prices in China over the last four seasons have led to a structural change in the Chinese textile industry. First Chinese mills resorted to cheaper cotton imports to stay competitive and then we saw a shift towards increased yarn imports, for which there are no quotas are necessary. This year will mark the first time that Chinese yarn imports surpass cotton imports and this trend is likely to continue as long as Chinese domestic prices remain inflated in relation to the world market.

That’s good news for ROW mill use, which is why the USDA is raising its number for ROW mill consumption from 76.5 to 79.3 million bales. If the USDA proves to be correct with its assumption, then ROW mill use will have risen by 13.3 million bales or around 20 percent since 2011/12.

US export sales for the week that ended on May 7 came in above expectations, as a combined 145’500 running bales of Upland and Pima were sold for both marketing years, whereof 66’200 running bales were for May/July shipment and 79’300 running bales for August onwards. There were still 15 different markets participating, with Salvador (28’300 bales) and Turkey (24’000 bales) taking the biggest amounts. Total commitments for the current marketing year now amount to just under 11.0 million statistical bales, whereof 8.2 million bales have already been exported. The 2015/16 marketing year has so far 1.2 million bales on its books.

The US dollar continued to weaken this week, which helped to underpin commodity prices. The US dollar index has now lost nearly 6 percent in just the last four weeks and there is no end to the slide in sight as “the great unwind” out of the US dollar continues. Until a couple of months ago the US economy was hailed as the strongest among developed nations, but after a slew of disappointing economic reports the US seems to have lost its luster. Wednesday’s retail sales report for April showed no growth and sales have now risen by just 0.9 percent over the past 12 months.

Six years into this so-called recovery we have yet to see any substantial improvement in the US economy and analysts are beginning to realize that this anemic growth may not change anytime soon. Consumption makes up about 70 percent of US GDP, but many consumers seem to be unable to spend at the pace they used to. The Fed’s zero interest policy is depriving the older generation of income on its savings, while young people find it difficult to get jobs and to pay off student loans (USD 1.3 trillion!). Many companies are not expanding in the current environment and instead borrow cheap money to buy back shares in order to prop up their stock price. All of these factors do not add up to a quick turnaround!

So where do we go from here? The tight supply situation, especially in premium grades, will only get tighter until new crop brings relief, which should keep prices well supported in the second and third quarter. US dollar weakness is another element of support, although it remains to be seen whether this is just a countertrend rally or something longer lasting. We expect prices to trade between 63 and 68 cents in the foreseeable future, with an outside chance for a rally into the low 70s on short covering.

If the USDA is correct with its forecast and the ROW surplus drops from 12.8 to just 5.0 million bales next season, there is no reason to expect any undue price pressure. The fact that Chinese cotton imports are becoming less of a factor won’t hurt the market as much as some commentators may fear, especially since Chinese yarn imports are picking up the slack, which bodes well for ROW mill use going forward.