Market Comments – December 11, 2014

NY futures were able to consolidate last week’s gains, as March moved 6 points higher to close at 60.48 cents/lb.
There are a several reasons why this bear market has been able to defy gravity lately, such as an improving technical picture, stronger competing crops and the prospect of better retail sales thanks to cheaper energy prices. However, the main driver has been the limited availability of cash cotton in the system, as government support in the US and India continues to restrict the flow of supplies. 
While on paper there is certainly more than enough cotton around the globe to justify a bearish outlook, with some analysts still projecting prices to drop into the 40s at some point this season, the reality is that the three largest producers in the world are currently preventing their massive supply from entering the marketplace.
China has by far the biggest stockpile with an estimated 62.6 million bales, but most of that inventory remains locked away by the government, with no clear indication as to when and at what price it might be made available. It is highly unlikely that Chinese cotton will be exported anytime soon, not with the current price differential to the international market, which still amounts to over 30 cents/lb. As long as this premium exists, China will continue to be a net importer of cotton and yarn, albeit at a slower pace.
In India the CCI (Cotton Corporation of India) has already taken up more than 2.2 million local bales so far, with over 340 procurement centers operating across India. Combined with a slightly smaller crop than expected due to some issues in Maharashtra, it is unlikely that we will see price pressure from India anytime soon. 
The CCI could easily absorb 6-7 million bales from the market, possibly more, and thereby keep local prices on a firm footing until later in the season, when these stocks will be made available again. There has been some talk this week about a potential export subsidy for Indian cotton as well as import duties on foreign cotton, but so far these are just rumors. For now Indian cotton remains mostly uncompetitive on the international front.
The world’s largest exporter, the US, has seen its balance sheet tighten quite considerably this week, as the USDA slashed its production estimate by 474’000 bales to just 15.92 million bales. Furthermore, weekly US export sales continued to impress, with another 200’800 running bales finding a home last week.
With US supply now at just 18.37 million bales and domestic and export commitments already at 11.0 million bales, the remaining supply of 7.37 million bales looks a lot less threatening. Assuming that there needs to be a carryover of at least 2.5-3.0 million bales at the end of the season to bridge the gap to new crop, availability for the remainder of the marketing year is now below 5 million bales. That may still prove to be a lot, especially if the top two importers China and Turkey were to disappear from the scene, but at the moment there is no pressure on the US market, quite to the contrary!
With the AWP (Adjusted World Price) not moving by much next week, going up just 9 ticks to 46.45 cents, growers are in no hurry to take cotton out of the loan. So far only about 3.5 million bales of current crop cotton has been freed from the government system via loan redemptions or POP payments, which is still not nearly enough to satisfy existing commitments. Even if we add in beginning stocks of 2.45 million bales, “free” supplies amount to only around 6.0 million bales thus far, against 11.0 million bales in commitments. No wonder basis levels have been so strong recently!
What is urgently needed is a spike in the AWP in order to flush out several million bales at once rather than this slow trickle we have experienced so far. In order to achieve that we need West African prices to rally. Believe it or not, the AWP is currently based entirely on African quotes – four West African growths (Benin, Burkina, Ivory Coast and Mali) plus Tanzania. Unlike the A-index, which allows only two West African origins to form part of its calculation, the US government takes the five cheapest quotes to determine how much of a loan deficiency payment US taxpayers are on the hook for. 
Currently these West African origins are quoted more than 300 points below those of its main competitors, the US and India. Tanzania is quoted somewhere in between, but was made ‘nominal’ this week, which means that it will likely disappear soon. According to the latest USDA figures, combined exports of these four West African growths plus Tanzania will amount to just 3.35 million bales this season, which is less than 10% of global trade. In other words, supplies won’t last forever and we therefore expect to see some upward pressure on the AWP over the coming weeks.
Wednesday’s USDA report contained another big surprise next to the already mentioned drop in US production, as global consumption came in 1.25 million bales lower than last month at 112.6 million bales. Mill use in China and India was cut by 0.5 million bales each, while Brazil, Pakistan and Turkey were down 0.1 million bales each. With the US economy starting to show some strength, with cotton prices now able to compete against man-made fibers and with crude oil prices near 60 dollars, we are more optimistic on consumption than the government.
US retail sales for November showed the first sign of strength in reaction to the cheaper cost of energy, as total sales were up 0.7 percent, with clothing stores showing a 1.2 percent increase. As already mentioned last week, cheaper gas prices provide a huge stimulus, with the average US household saving around 1’400 dollars a year based on current prices at the pump. With consumers around the globe experiencing similar savings, we have no doubt that there will be an increase in discretionary spending over the coming months, which should bode well for cotton consumption. 
So where do we go from here? There is a lot of cotton around the globe, but unless it is allowed to play in the market, it won’t be able to exert any price pressure. For that to happen we first need to see prices move higher in order to free up some of these locked up supplies. A jump in the AWP would achieve that objective and flush a large amount of cotton out. Only once the bulk of the US crop is out of government hands will prices start to feel some pressure and possibly challenge the lows again. Keep an eye on West African prices, since they hold the key in this AWP puzzle!