NY futures closed on a positive note this week, with May advancing 61 points to close at 63.69 cents, while December gained 21 points to close at 64.54 cents.
The spot month continued to move sideways within a very tight closing range of just 117 points this week, oscillating between 62.52 and 63.69 cents. The resulting ‘flag’ formation, which has the May contract still consolidating above the breakout session of March 18, bodes well for another move higher in our opinion. Furthermore, the 200-day moving average is starting to come into the picture at around 64.50 cents and could trigger a wave of spec buying if taken out.
The latest CFTC report revealed that speculators kept their powder dry during the week of March 18-24, as large spec longs (-3’235 lots) as well as spec shorts (-11’698 lots) both reduced their respective positions. With the market moving sideways, speculators don’t seem to be too interested in cotton at the moment, but with a net long position of just 2.7 million bales they have plenty of firepower available in case the market provides them with a reason to re-enter.
The market reacted surprisingly well to a US export sales report that came in below expectations this morning, with net sales of Upland and Pima only adding up to 65’400 running bales for both marketing years. There were 16 markets listed as new buyers this week, while 11 markets reported cancellations totaling 49’700 running bales. However, as we have pointed out before, cancellations don’t necessarily mean that buyers have no use for the cotton anymore, but rather that shippers may be unable to locate suitable US high grades.
Shipments were the bright spot in today’s export sales report, totaling 332’700 running bales to 26 destinations. Total export commitments for the current marketing year now amount to 10.5 million statistical bales, whereof 6.2 million bales have so far been exported. Sales for the 2015/16 marketing year remain at around 0.9 million bales.
The USDA’s Prospective Plantings report, which was released on March 31, marked the starting point for the new crop guessing game. US acres are expected to drop to just 9.55 million acres in the coming season, down about 13 percent from the current year. This marks only the third time this century that acreage is dropping below 10 million acres, the previous two occasions were in 2008 and 2009, when final acreage came in at 9.47 million and 9.15 million acres, respectively.
In 2008 US crop production reached 12.8 million bales, while in 2009 it dropped to just 12.2 million bales. We are a bit more optimistic for the coming season, mainly because the cotton belt from Texas to the Southeast has plenty of subsoil moisture, and with El Niño to remain in place for most of the growing season, yields are probably going to be above average. For this reason we feel that the US crop has the potential to reach 13.5 to 14.0 million bales.
Looking around the globe, China’s acreage is expected to drop by about 20 percent, which would put production at around 24-25 million statistical bales. India and Pakistan may see some small reductions, but by and large we feel that global production is not likely to drop by more than 11-12 million bales from this year’s level of over 119 million bales.
Despite stiff competition from man-made fibers, we expect global mill use to increase slightly over the course of next season, to somewhere in the neighborhood of 113-114 million bales. Therefore, if our assumptions about production and mill use were correct, then we might see the first production gap in six seasons, to the tune of around 5-6 million bales.
As we have all learned over the last four seasons, international prices are mainly a function of the ROW balance sheet, which saw its ending stocks increase from around 39 to 45 million bales this season. Unfortunately it doesn’t look like these ending stocks are going to drop by much next season. If the ROW were to reduce its production by a little over 6 million bales to 83 million bales, while at the same time increasing its mill use by 2 million bales to 78 million bales, then the ROW surplus would drop from around 13 million to 5 million bales. However, since Chinese imports are also expected to be curbed further next season, to possibly no more than 5.0-5.5 million bales, they would just be enough to absorb the seasonal ROW surplus, but not more.
So where do we go from here? Although the global balance sheet may finally start go get rid of some of its excess stocks, most of this stock reduction will happen in China, whereas ROW inventories are not expected to change by much. For this reason it is difficult to construct a bullish case at this point and it may explain why December has been confined to a 600-point range for the last six-and-a-half months. However, we are still early in this guessing game and a lot can and probably will happen before the next crop is harvested.
While we are neutral on new crop, we remain friendly on May and July, both from a fundamental and a technical point of view. US tenderable grades are for all practical purposes sold out and the chart is starting to look constructive. We therefore see the downside as limited to perhaps 2-3 cents, while a short-covering rally might still force prices into the high 60s or even low 70s over the next two-and-a-half months.