NY futures rebounded since our last report on May 21, with July gaining 149 points to close at 65.12 cents, while December added 58 points to close at 65.28 cents.
The market continued to meander in its long-term sideways trend, during which July has been confined to a 59 to 68 cents range since last September. The trading band for new crop has been even tighter, with December moving within a 61-67 cents range for nearly nine months now.
Unfortunately the statistical picture does not lend itself to construct a bullish or bearish case at this point. Based on the latest USDA numbers we should see only minor changes in inventory levels outside of China. Although the ROW (rest of the world) production surplus is going to be considerably smaller than last season, so are Chinese imports, and since these two numbers are expected to cancel each other out, there will be virtually no change in ROW ending stocks. It will therefore take a major event to get the market out of its dormancy, such as a crop failure, demand issues or some big shifts on the economic/currency front.
The US crop has had a rather difficult start to the new season, as El Niño has dumped copious amounts of rain over Texas and the Mid-South, while the Southeast didn’t get quite enough of it lately. Although rain is usually great for agriculture, especially in dry areas like Texas, too much of it can cause problems.
El Niño conditions are now firmly in place, with sea surface temperature anomalies in parts of the Pacific five times above those of a normal El Niño. A warmer ocean releases more moisture into the atmosphere and these vapor plumes are being picked up by the Jet Stream and then get transported to the continental US. When these “atmospheric rivers” - which can carry more water than the Amazon River - hit a cold front and rain out, they create flood conditions like Texas and the Mid-South experienced during May.
Traders are still trying to assess the potential of the US crop. There is no doubt that some acreage has been lost due to the wet weather, both in Texas and the Mid-South. However, if growing conditions were to improve from here on forward, then the crop potential is still substantial. For example, if the US were to harvest 8 million acres (vs. 9.55 intended) and the yield came in slightly above average at let’s say 850 lbs/acre, then the crop would still amount to 14.2 million bales, which is what the USDA currently has.
What’s worrisome though is that El Niño has an approximately 90% chance to last through the Northern Hemisphere summer, and a greater than 80% chance that it will last through 2015. This poses a threat in regards to yield and quality to a US crop that is already behind schedule. Another large crop that could be impacted by El Niño is India, which tends to see its Monsoon disrupted when this phenomenon is present. The Indian Monsoon typically runs from around the middle of June through September.
The trade is therefore reluctant to short the futures market in the low 60s, not knowing what the outcome of these crops will be and having only a limited amount of current crop cotton left to provide back-up. This may be the reason why US export sales continue at a relatively brisk pace week after week, despite the fact that there are probably less than 2 million bales of mostly mixed qualities left to choose from.
US export sales for the week ending May 28 were 161’400 running bales for both marketing years, whereof 107’600 bales were for June/July shipment and 53’600 running bales were for August onwards. There were still 16 different markets participating, with Vietnam and Turkey leading the way. Shipments were once again excellent at 309’100 running bales. Total commitments for the season have now reached 11.3 million statistical bales, whereof 9.3 million have already been exported. Considering the amount of sales and the pace of shipments, it is almost a given that the USDA will have to raise its current export estimate of 10.7 million bales, possibly by as much as 0.5 million bales.
So where do we go from here? Short covering in July seems to have been behind the market’s strength this week, while potential sellers are being cautious to lean too heavily on the short side given the issues with the US crop. However, from a physical price point of view the futures market is getting pricey near 66 cents, since it implies a C&F price of around 75 cents landed Far East for a 41-4-34 piece of cotton. The certified stock, which is approaching 150k bales and contains plenty of short staple cotton, should therefore become a deterrent to potential takers, especially in the absence of any carry. Therefore, unless the US or Indian crops encounter further problems, we see the upside as limited.
However, the same is true for the downside, since merchants and growers are not likely to aggressively sell futures or physicals until the outcome of the Northern Hemisphere crops is known, which will not be the case before October. We therefore see December well supported in the low 60s over the coming months.
In other words, we don’t expect the market to break out of its long-term sideways trend anytime soon!