Market Comments – December 18, 2014

NY futures settled at their highest level in five weeks, with March moving up 34 points to close at 60.48 cents/lb.

Ever since the March contract dropped over 500 points in a matter of four sessions following the November WASDE report, it has been working diligently to get itself out of this hole. Even though March closed the last 24 sessions in a very narrow range of just 201 points, between 58.81 and 60.82 cents, we are starting to discern a slight upward bias on the chart.

This five-week consolidation period has given moving averages a chance to catch up with the market and March has already crossed above its 20-and 40-day moving averages and is now challenging the 50-day, which sits just below the important 61 cents resistance area today. Although the market has managed to move above 61 cents on several occasions recently, it has so far been unable to hold this level on a closing basis. However, despite several rejections the market seems poised to try again and if it manages to settle above last week’s high of 61.25 as well as the 50-day moving average, it will likely trigger a wave of spec short covering.

The latest CFTC report of December 9 showed speculators 1.8 million bales net short overall, but outright shorts amounted to 7.4 million bales and they could provide the fuel to propel the market higher. If specs were to cover some of their shorts, the trade would likely be on the other side in an effort to lock in a favorable spread to the AWP. The trade is currently just 3.4 million bales net short and certainly has room to expand its position. Index Funds continue to be the only group that is on the long side of the market at the moment, with a 5.2 million bales net long position. This position is likely to grow in early January, when the annual rebalancing takes place. Current estimates project an additional 7’500-8’000 contracts to be bought by Index Funds between January 8 and 14.

 From a fundamental point of view there is some justification to move a little higher as well, since A-index quotes and hence the AWP have started to turn up, thereby lifting the base calculation for US cotton. Thanks to Tanzania dropping out of the calculation and being replaced by a more expensive Indian quote, the AWP is moving 121 points higher in the coming week, going from 46.45 to 47.66 cents. Based on today’s quotes, the daily AWP calculation was even above that at 48.01 cents.

It will be interesting to see how much cotton gets flushed out of the loan system before the new rate takes effect at midnight tonight. So far only an additional 0.8 million bales have been freed from the loan this week, bringing the seasonal total to around 4.3 million bales. That’s not nearly enough to alleviate the tight supply situation we are in and unless a lot more cotton gets freed up by tonight, we don’t expect to see any price pressure develop, which means that the loan game will continue, albeit at a slightly higher level.

On the other side of the globe, in India, the CCI continues to absorb cotton at the MSP at a rapid pace, with nearly three million bales already having been procured so far. However, unlike China the CCI does not plan to sit on its inventory for an extended period of time and has already asked the government for permission to start disposing of its stocks in January. This comes as a surprise, since most observers felt that India would not sell its stocks before most of the crop is out of grower hands. Depending on the terms these stocks will be offered, this may turn out to be a bearish development for the market.

As we are about to enter 2015, the market’s focus is starting to shift towards planting intentions in the Northern Hemisphere. Most analysts agree that at current prices we will see a drop in global cotton acreage next season, but the question is where and by how much? We still live very much in a two-world market, with prices in China exceeding those in the rest of the world (ROW) by around 30 cents/lb. China’s current policy is designed to bring down its massive stockpile by reducing both production and imports, with the latter being the main reason why prices have come under so much pressure over the last seven months.

But is the ROW really dependent on Chinese imports going forward? When we look at the current season, the ROW is expected to produce a surplus of 13.38 million bales, which is only partially being offset by Chinese imports of 7.0 million bales, thereby resulting in an increase in ROW ending stocks from 38.9 to 45.4 million bales. However, if plantings in the ROW were to drop next season while mill use increased, it would quickly erase this production surplus.

For example, if ROW production of currently 89.0 million bales were to drop by 10% due to lower acreage (= 8.9 million bales less), while ROW mill use of currently 75.6 million bales were to increase by let’s say 5% (= 3.8 million bales more), the ROW production surplus would shrink to just 0.7 million bales next season. If we further were to assume that China continued to import a minimum of 4-5 million bales (based on the TRQ under the WTO framework), then ROW stocks would actually start to fall.

It is still early in this numbers game and a lot can and probably will happen before final planting decisions are made next spring, but the above assumptions don’t seem unrealistic, especially if cotton prices were to drop into the mid-to-high 50s, as so many traders still believe.

So where do we go from here? The market is once again getting close to technical resistance near 61 cents and maybe this time it will be able to trigger a spec short covering rally. We therefore don’t rule out a quick move towards 63-64 cents, but don’t think that it would be long-lasting since the trade would emerge as a heavy scale up seller.

For prices to challenge the recent lows we would need to see large loan redemptions first, but that doesn’t seem to be in the cards at the moment. The US is still behind in getting cotton into the system to cover the 11.1 million bales in commitments and for this reason price pressure is unlikely to materialize at this point. However, we need to keep an eye on India, which may make an earlier than expected move on the export front and dispose of its recently acquired CCI stocks.