Market Comments – July 7, 2016

NY futures moved higher during this holiday-shortened week, as December gained 98 points to close at 65.15 cents.
 
The market stayed in a sideways pattern without much conviction and December has now closed the last 29 sessions in a 299-point range between 63.00 and 65.99 cents. Momentum indicators are flat, volume has been lackluster and open interest has come down slightly over the last few session.
 
However, since this sideways trend is currently trapped in a narrowing flag pattern, it will only be a matter of days until December either breaks above the 66.50 resistance area or crosses below a 4-month uptrend line that currently runs through around 64.25 cents. It is difficult to determine what the market’s next move will be, since we are still in a tug-of-war between a bullish near-term scenario and a potentially bearish new crop outlook.
 
This week the Chinese futures market traded around 15,000 yuan/ton, which is about 50% higher than in early April, while India’s futures market is up around 35% during the same time frame. Cash prices in both markets remain considerably above the A-index (75.90 cents), with Chinese mill prices in the mid-to-high 90s and Indian mill prices in the high 80s.
 
Sooner or later the USDA will have to reflect these tight conditions in China and India by dropping its ending stocks numbers. China is releasing a lot more of its Reserve cotton than anticipated, as already over 5.1 million statistical bales have been auctioned off, with no end to the buying frenzy in sight. Chinese ending stocks should therefore be lowered by at least 2-3 million bales, possibly more.
 
The same goes for India, where local sources peg ending stocks at no more than 2.0-2.5 million Indian bales or 1.6-2.0 million statistical bales by the end of September, which marks the end of the marketing year in India. By contrast, the USDA has ending stocks in India at 11.04 million statistical bales by the end of July.
 
Since there is a two-month difference between the respective marketing years, we need to reduce the USDA number by around 4.3-4.5 million statistical bales to account for mill use and some exports during August and September. But this still leaves a rather big discrepancy, with the current USDA estimate being around 4.5 million bales overstated.
 
While global ending stocks should see some sharp downward revisions, with stocks outside China reaching their lowest level since 2009, the outlook for larger crops next season has so far kept the NY futures market in check. At this point the market counts on bigger crops than last season in the US and the Indian subcontinent, which account for about 64% of cotton production outside China. So far the crops look promising, but any setback could light a fire under the market.
 
We are not sure that buying December futures works for those trying to capitalize on a bullish near-term outlook. December is a new crop month, and if the US crop turns out to be as big as promised and arrives on time, there will be plenty of time to put cotton against the board if December trades at an elevated level. Therefore, we believe that the bullish near-term scenario will instead be played out in a strong basis, which should reach its highest level in July/August and then tapers off as we move towards harvest.
 
So where do we go from here?  Form a technical point of view the market should see some action over the coming sessions, as December is going to breach either support or resistance, which will likely trigger a reaction by speculators. A move above 66.50 would lead to another wave of spec buying and possibly propel December towards 70 cents, while a drop below support (currently at 64.25) would wash out some existing longs and thereby force values lower.
 
While we don’t recommend chasing the market higher unless there is a crop problem, we would welcome a chance to buy the market on a selloff towards 62/63 cents. We feel that there is relatively little downside risk beyond that level over the next couple of months, given the extremely tight pipeline stocks and the still uncertain outcome of new crop. Also, there are currently around 6.4 million bales in unfixed on-call sales, which would provide solid support on a move into the low 60s.

 

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