Market Comments – March 31, 2016

NY futures rebounded this week, as May gained 72 points to close at 58.44 cents/lb.
 
The market ended the first quarter on a strong note, as the May contract rallied to its highest close in five weeks. After losing over 1100 points between December 9 and February 29 on heavy spec selling, the market has since transitioned into a sideways consolidation pattern, closing the last 19 sessions in a tight range of just 185 points. There have been several attempts to break above resistance at 58.50 cents on a closing basis, but so far to no avail. It will therefore be interesting to see whether today’s strong move will finally get some follow-through momentum or whether it was just another flash in the pan.  
 
The latest CFTC report showed that after selling 10.4 million bales net over a 14-week period, speculators finally turned net buyers during the week of March 16-22, reducing their net short by 0.3 million bales. However, speculators nevertheless still sit on a near record 4.1 million bales net short and a 10.2 million bales outright short position. In other words, there is plenty of ammunition available for a potential short-covering rally!
 
Today’s USDA planting intentions report was a typical “sell the rumor, buy the fact” event. Even though the number came in at the higher end of expectations and the market initially sold off, traders eventually seemed to figure out that mills in need of cotton between now and new crop won’t be able to spin intentions. Furthermore, news headlines touting a huge increase in acreage compared to last year are somewhat misleading, because they compare intentions with final planted acreage.
 
When we compare intentions with intentions, we find that farmers are planning on about the same acreage as last year, 9.56 million acres vs. 9.55 million acres a year ago. In fact, when we look at Upland acreage, the 9.35 million acres are slightly less than the 9.4 million farmers intended to plant twelve months ago. Over the next three months weather and price will decide what the final acreage looks like, but it is already clear that it will be another relatively small US crop, since the intended 9.35 million acres of Upland are still the 3rd lowest since 2000.
 
Today’s US export sales report showed that last week 134,200 running bales of Upland and Pima were sold, whereof 35,200 were for shipment after August. Participation remained broad based, with 18 markets buying and 25 markets receiving shipments of 205,800 running bales. Total commitments have now reached 7.8 million statistical bales, whereof 4.9 million bales have so far been exported.
 
Although many commentators voiced their disappointment about the recent pace of US exports, we have to allow for the possibility that US export sales have slowed due to the unavailability of desirable grades, rather than lousy mill demand. Let’s not forget that we had a relatively low quality season and since we estimate that only around 3.3 million bales of Upland cotton remain for sale at this juncture, there are probably not too many premium qualities left for sale.

If mills can’t find what they need in the US anymore, they will have to turn to other origins, such as West Africa or India. However, since availability in these origins is getting tighter too, we may eventually see some upward price movement in the cash market. If that were to happen in these aforementioned origins, which make up all of the current quotes used to calculate the AWP (4 West African + 1 Indian quote), the AWP would start to rise by several cents, which in turn would pull the futures market along with it.
 
China is still the main reason why the market remains stuck in a bearish mindset. Although the Chinese government has announced what it wants to sell and when, what’s missing so far is the price at which these reserve bales will be made available. We believe that the reason behind this has to do with the unsold stock in Xinjiang, where an estimated 1.8-2.0 million tons remain for sale. Xinjiang still insists on prices of around 12,000 yuan/ton for top grades, whereas the CNCE and ZCE forward prices for mid-year delivery are around 1,500-2,000 yuan/ton lower.
 
We believe the government's dilemma is how to fit into all this with its reserve auctions. If it offers reserve cotton a lot cheaper than what Xinjiang producers want, it will undercut their sales effort and create resentment. On the other hand if the reserve price is too high, then the same as last year will happen and hardly anything gets sold. By delaying the announcement the government seems to allow Xinjiang more time to dispose of its supplies.
 
However, the real problem is that there is simply not enough room to accommodate Xinjiang growers and the Reserve. According to our figures, China produced a crop of around 4.8 million tons this season and it will import around 1.0 million tons, for a seasonal supply of some 5.8 million tons. Against that we estimate mill use at somewhere between 6.3-6.5 millions, which would leave a shortfall of around 0.5-0.7 million tons. The USDA has higher numbers for both production and mill use, but its seasonal shortfall is similar at 0.7 million tons.
 
Therefore, either the Reserve will fall short of its goal to significantly reduce its stocks, or Xinjiang producers will get stuck with a large carryover. The only other option would be exports, and maybe that’s what the market is so nervous about. But exporting heavily subsidised reserve cotton is not a good idea under WTO rules, while Xinjiang cotton is currently too expensive for the world market. Since we don’t see exports as an option in the near future, we believe China will take a cautious approach with its initial reserve auctions in order not to affront Xinjiang.
 
So where do we go from here? The next few sessions will show whether today’s bounce and the growing inversion between current and new crop have some legs or whether it was just tied to some end of quarter profit taking by speculators. The market may have to tread water for a while longer, but over time we feel that dwindling supplies in the cash market will lead to higher futures prices, especially in current crop.
 
China’s reserve price policy will be an important factor in all this, but we believe that the market has already discounted all but the most bearish scenarios, which would be exports and/or dumping prices. Since we don’t expect either in the near future, we remain friendly on May and July, as well current crop vs. new crop spreads.

 

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