NY futures drifted slightly lower this week, as March gave up 73 points to close at 61.36 cents.
It was yet another week of indecision in the cotton market, as a potentially bullish supply situation continues to be overshadowed by uncertainty about the Chinese reserve policy and the global macro environment. Although the market came under renewed pressure when it broke below short-term support on Tuesday, the damage was kept under control and buying finally resurfaced again today.
The tightening supply picture continues to keep bullish hopes alive, as global output is now widely expected to fall below 100 million bales this season, which would be the lowest since 2003/04 and over 20 million bales less than a year ago. While our own number is a shade below 99 million bales, Cotlook has an even lower estimate at just 97.5 million statistical bales. By contrast, the USDA is still at 101.6 million bales, but we have a feeling that this number might have to be scaled back over the coming reports.
This disappointing global production number is the result of both lower acreage and lower yield. While global harvested acreage was around 10% down from last season, yield suffered an 8% drop compared to a year ago. This is somewhat unusual, because El Niño years typically produce fairly decent crops.
Interesting too is that the year-on-year decline in production happened all across the globe, with not one major producing area showing an increase. The biggest drop, according to our own numbers, occurred in China (-6.5 million bales), followed by Pakistan (-3.5 million bales), the US (-3.4 million bales), India (-2.1 million bales), Turkey (-0.6 million bales), Central Asia (-0.5 million bales), Brazil (-0.4 million bales) and West Africa (-0.25 million bales).
Global mill use has seen a decline as well, but not nearly to the same degree as production. While our own number is at 107.8 million bales, Cotlook is a little more downbeat at 106.6 million bales. The USDA is once again quite a bit higher than the consensus and has mill use still at 110.9 million bales, mainly due to a more optimistic number for China.
Even though there are some differences between the Cotlook and USDA numbers, when we look at just the spread between production and mill use, both organizations arrive at nearly identical production gaps for the current season. While Cotlook has a production gap of 9.1 million bales, the USDA is at 9.3 million, and our own numbers show an 8.9 million bales deficit.
As a result ending stocks outside China are estimated to be drawn down by somewhere between 4 and 6 million bales, which could make the second half of the season quite challenging for mills. The quality mix is not nearly as great as in previous years and we therefore believe that premium grades with decent staple lengths are starting to disappear first, then medium grades and if nothing else is available, even the less desirable recaps will find takers. Most of the premium grades around the globe have already transitioned from growers to merchants and now exist as basis-longs on their books, waiting to be sold to mills down the road.
While mills are still in a hand-to-mouth buying mode due to the uncertain economic outlook, we would recommend to lock up better grades now, because they might not be available anymore four or five months from now!
Last week we commented on the composition of the certificated stock, which we didn’t think was very desirable because the majority was made up of 1.1/32 and 1.1/16 staple cotton. We were therefore a bit surprised by the more than 25,000 bales in de-certifications this morning. This means that the certified stock has been cut in half this month, from 64,000 bales on January 1st to just 32,000 bales today.
Our guess is that these de-certs were part of the 31,000 bales in 2014 cotton, which was assessed an extra 200-point crop year penalty at the beginning of this year. Nevertheless, this sends a signal that some of the certified stock seems to be cheap enough near 60 cents. Furthermore, with the US crop yielding less than 7 million bales of tenderable grades this season, it will become increasingly difficult to replace the withdrawn bales as we move into spring and summer.
We believe that the US dollar will become an important factor in determining commodity prices over the coming months. Capital flight from all over the globe, favorable interest rate differentials and the apparent strength of the US economy were some of the reasons for the dollar’s extraordinary strength over the last couple of years. However, we feel that this bull run by the greenback is getting long in the tooth!
With the exception of the jobs number, nearly all of the US economic data has been quite negative lately, suggesting that the US might actually be at the brink of a recession. The selloff in the stock market has added further fuel to this argument. So far the Fed has been hanging its somewhat hawkish hat on the ‘encouraging’ jobs picture, but we feel that it is just a matter of time until that changes as well and the Fed has to concede defeat.
Once that happens and Fed policy once again becomes accommodative, it will in our opinion reverse the bullish dollar trend. This in turn would put support under all dollar denominated assets, including cotton!
So where do we go from here? We feel that the cotton market wants to go higher, but won’t be able to do so until the Chinese reserve policy has been decided. Markets don’t like uncertainty, and right now we have plenty of it. Nevertheless, there is no denying that premium grade supplies are tight and will only get tighter in during the second half of the season. We therefore recommend booking needed supplies without any further delay, if desirable on-call, and then fix the price on a break, possibly after the Chinese policy announcement. We wouldn’t be surprised if the Chinese news turned into a “sell the rumor/buy the fact” event that offers a great buying opportunity!