NY futures advanced this week, as December gained 181 points to close at 69.31 cents.
For the second week in a row the market challenged the 70 cents mark, with December posting an intra-day high of 70.05 cents/lb today, but it has so far been unable to overcome resistance at this psychologically important level. This week’s catalyst was a constructive WASDE report, which surprised many traders who were positioning themselves for slightly bearish numbers.
The USDA supply/demand report needs to be looked at in three parts, namely the US, ROW and Chinese numbers. The US numbers, which seem to have the biggest influence on NY futures, got the bulls excited as US ending stocks were substantially reduced, dropping from 4.9 to 4.3 million bales. This was due a 0.1 million bales reduction in the US crop and a 0.5 million bales increase in US exports.
However, many traders struggle with both of these changes, as the US crop seems to have greater yield potential than 797 lbs, which is about 30 lbs below its ten-year average, while exports of 12.0 million bales may prove to be a tall order considering that competing exporters like India, West Africa, Australia and Brazil are all expected to produce bigger crops than last season. But even if the US were to see its ending stocks at 4.3 million bales next summer, it would still amount to 0.5 million bales more than last season.
When we look at a year-on-year comparison of production, we have ROW production increasing by 7.37 million bales or about 10%, from 74.32 to 81.69 million bales. ROW mill use however is expected to gain only 0.22 million bales, going from 76.31 to 76.53 million bales. In other words, current projections see the ROW produce a surplus of 5.16 million bales.
This would be enough to satisfy Chinese imports of 4.5 million bales and allow ROW ending stocks to recover slightly from the extremely tight levels we experienced this summer. We therefore see the ROW numbers as neutral to slightly bearish at this point, even its US subset.
The Chinese numbers are another story, as production of just 21 million bales is expected to fall 14.5 million bales short of mill use, which is pegged at 35.5 million bales. Even after applying imports of 4.5 million bales, there still remains a shortfall of 10.0 million bales. Luckily China carries a lot of stocks to bridge this gap - 58.2 million bales at last count.
The latest stock revision by the USDA doesn’t really change the overall situation by much, as China has enough inventory to feed its mills for another 2-3 seasons. Assuming that China will want to keep its strategic stock at somewhere between 25-30 million bales, or 7-8 months of domestic mill use, it would still need to get rid of around 30 million bales.
We therefore see no immediate impact on the global market, although the large price spread that currently exists between Chinese and ROW prices might act as a magnet for yarn imports, which in turn could translate into higher mill use in the Indian subcontinent, Bangladesh and Vietnam. However, we feel that this big price disparity between China and the ROW will start to vanish over the coming months.
The price spikes we have seen over the last couple of weeks were different from the rallies we saw in August and September. Back then it was speculative buying that pushed prices higher, but now it is trade short covering that does the work. We can deduce that from the latest CFTC report and the drop in futures open interest.
Last week, on October 4th the market rallied to just below 70 cents after three straight winning sessions, but the CFTC report of that day showed that speculators had cut their net long by 0.79 million bales to 8.35 million bales during that week, while the trade reduced its net short by 0.74 million bales to 15.6 million bales.
The same happened yesterday when the market rallied nearly 200 points, but open interest in December dropped by 2,328 contracts, signaling that it was short covering by the trade that propelled the market higher. We suspect that some of the 8.3 million bales in unfixed on-call sales, of which 2.3 million are in December, are losing their patience after missing several dips to reduce their exposure and are starting to chase after the market.
So where do we go from here? The market is still locked into a trading range, with solid underlying support from 8.3 million bales in unfixed on-call sales, while origin selling above 70 cents seems to keep a lid on it for now.
By purchasing so many bales with the price ‘yet to be determined’, mills have created a problem for themselves! Every time the market tries to sell off, there is a wall of mill fixations preventing prices from falling too far and sooner or later frustrated mills are starting to step in front of each other in order to get their fixations done. In addition to the buying related to mill fixations we also have sales from merchant basis-long positions that trigger buying (sell cash cotton / buy futures).
In other words, whenever the market dips towards the mid-60s, there are plenty of buyers wanting to act, but not enough willing sellers. Growers won’t sell in the mid-60s but instead wait for prices above 70 cents. Speculators seem to get out of long positions lately, but they too wait for rallies to do so. Therefore we have a situation in which the market can’t go too far down, while it also struggles to get through overhead grower and spec selling. There is nothing to suggest that this situation is going to end anytime soon!
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