NY futures came under renewed pressure this week, as July dropped 159 points to close at 63.53 cents, while December gave back 90 points to close at 64.38 cents.
Just when it looked like the market was gaining some upside momentum, a news story out of China was all it took to knock the wind out of the market today. Speaking at the ongoing Cotton Conference in Ningbo, a vice-director of the NDRC announced that a plan for the release of reserve cotton was forthcoming within the next ten days.
The market seemed to interpret this news as bearish, possibly fearing that China might open the floodgates to its massive reserve stocks. We don’t see it this way for a variety of reasons. First of all, from a statistical point of view there isn’t really any room for China to push cotton into the marketplace, unless it were to become active as an exporter, which is highly unlikely given the huge price disparity between China and the rest of the world. The NDRC representative furthermore stated that their plan would aim at market stability and that they would act in a cautious manner in order to not depress prices. If China were to pursue exports, both of these objectives could not be met!
If we look at China’s domestic market, we expect a 2015/16 crop of around 5.6 to 5.8 million tons and domestic mill use of 6.5 to 6.7 million tons (we consider the USDA estimate of 7.8 million tons unrealistic). In other words, we may see a production deficit in China of just around 1.0 million tons. However, China is expected to import some 1.2 million tons (0.9 million tons under the WTO quota and 0.3 million tons for the processing trade) next season, which would already cover the potential production gap. Therefore, how can China fit in reserve sales under such a scenario?
One possibility is for China to rotate reserve stocks, by buying a million tons of new crop cotton and then releasing some of its 3-4 year old stocks under an auction scheme. However, based on what we know today, there is no easy fix to reduce China’s massive stockpile. Even though China has started to bring its production down by focusing on Xinjiang and forcing Eastern Provinces to look for alternatives, mill use has started to slip as well as more and more mills are importing yarn made from cheaper foreign growths. China currently imports more than 2 million tons of yarn annually and this trend will likely continue as long as this price disparity between Chinese and foreign cotton exists.
Although Chinese imports have shifted from cotton to cotton yarn in recent years, mainly due to quota restriction for cotton, China still imports well over 3 million tons of cotton and cotton yarn combined at the moment! This makes it difficult for policymakers to get this big inventory monkey off their back and to make matters worse from a Chinese point of view, it underpins foreign mill use. This is the reason why we see the current situation in China as somewhat supportive to international prices.
The most effective remedy to the Chinese predicament would be a narrowing of the price gap between Chinese and international prices. This would disincentivize imports, make Chinese mills more competitive, boost local mill use and eventually lead to destocking. Unfortunately the current policies are not geared towards this outcome and unless there is a major crop problem somewhere else, we are likely to see no change to the status quo.
Speaking of crops, favorable weather has improved crop conditions in the US and allowed additional acreage to be planted. There is still some confusion regarding the planted acreage number, but whatever made it in the ground has the potential for above average yields this season.
Recent weather forecasts out of India sound more optimistic as well, because a positive Indian Ocean Dipole (IOD) is likely to shield India from the negative effects of El Niño. A positive IOD means that low pressure develops off the coast of India, drawing wind flows from east to west, which assist the movement of the monsoon. Some monsoon predictions have therefore been raised to 102% of normal between June and September.
The improved monsoon outlook may prompt the CCI to become more aggressive in disposing its still large inventory of well over seven million local bales. This week the CCI started tendering cotton to both domestic and international buyers, with Bangladesh apparently showing keen interest. Most market participants expect a lowering of Indian prices over the coming weeks.
The USDA supply/demand report was anticlimactic, as there were basically no changes made to the 2015/16 estimates. The government seems to be waiting for more evidence before committing to a new set of numbers. However, there were a few adjustments made to current crop numbers, which we interpret a slightly friendly. The most significant were a lowering of the Indian crop by 0.5 million bales to 29.5 million bales and an increase in Chinese imports from 7.7 to 8.0 million bales. The net result of all the changes was a lowering of the ROW ending stocks by 540’000 bales, from 44.92 to 44.38 million bales.
US export sales continued at a decent pace last week, with net new sales totaling 136’900 running bales for Upland and Pima combined, whereof 53’700 running bales were for June/July shipment and 83’200 bales for August onwards. There were still 18 markets participating, with Thailand and Mexico leading the way this time. Shipments continued at a very strong pace, with 324’200 running bales crossing the border last week.
For the current season we now have total commitments of 11.4 million statistical bales, whereof 9.6 million have so far been exported. In other words, outstanding commitments are down to just 1.8 million statistical bales, with still eight weeks to go in the marketing year. Meanwhile new crop sales have reached 1.5 million statistical bales.
So where do we go from here? December, which is now the lead month, has slipped back to the middle of its 61 to 67 cents sideways trend. A break below 64 cents would probably spark a selloff towards the lower end of the range. Improved growing conditions in the US and possibly India have lowered the weather premium and the negative narrative out of China may invite some more spec selling. However, from a statistical point of view we don’t see any reason for a pronounced down move at this point, since the supply pipeline is fairly tight outside of China and India, and the outcome of new crop is still uncertain at this point. We therefore expect the market to remain in its sideways trend in the foreseeable future.