Market Comments – May 12, 2016

NY futures continued to slide this week, as July gave up another 106 points to close at 60.73 cents/lb.
This week’s USDA supply/demand report, which provided a first look at the 2016/17-season, added to an already bearish sentiment, pushing the market to its lowest close since April 15. 
However, when we sift through this latest set of USDA numbers, the story remains basically the same as it has been for months, namely that current crop inventories are tight, while a potentially larger 2016/17-crop should help to improve the supply situation outside China by the end of the year.
When we look at the ROW balance sheet for all countries other than the US and China, the latest USDA numbers show 2015/16 production at 62.86 million bales and mill use at 72.93 million bales, which results in a seasonal deficit of 10.07 million bales. This is just slightly less than last month’s 10.36 million bales deficit. 
While Chinese imports of just 4.25 million bales (down from 5.0 million last month) are adding less to this ROW deficit than before, lower US exports of only 9.0 million bales (down from 9.5 million last month) are contributing less to alleviate the shortfall. In summary, there remains a considerable seasonal production gap this season, which is why July has surrendered relatively little ground since the report has come out. 
The situation should improve in 2016/17 according to the USDA. ROW production outside the US and China is estimated to increase by 4.2 million to 67.06 million bales, while mill use is supposed to grow by 0.75 million to 73.68 million bales, for a seasonal deficit of 6.62 million bales. Since China is still expected to import 4.5 million bales next season, the projected shortfall outside the US would increase to 11.12 million bales, but US exports of 10.5 million bales would more or less fill that gap. 
If the current USDA estimate were to play out, we would have a situation in which a) ROW stocks (outside of China and the US) would drop slightly from 35.52 to 35.02 million bales by the end of 2016/17, b) Chinese stocks would also drop, from 63.32 to 56.72 million and c) US stocks would rise from 4.0 to 4.7 million bales. 
In terms of market impact a rise in US ending stocks is a bearish factor, while slightly lower ROW stocks are mildly supportive. The pronounced drop in Chinese inventories doesn’t have much of a near-term impact, but is a step in the right direction to correct the out of kilter global stocks-to-use ratio over the next few years. 
US exports for the week of April 29 to May 5 were slightly above expectations at 112,000 running bales of Upland and Pima for both marketing years combined. Participation remained broad-based with 17 markets buying and 23 destinations receiving shipments of 180,700 running bales. Total commitments for the season have now risen to 8.55 million statistical bales, of which 6.4 million bales have already been shipped and 2.15 million bales remain open. 
The USDA expects export sales to slow down considerably over the remaining three months, which is probably a reflection of the quality mismatch that exists between cotton on offer and what mills would like to buy. The USDA lowered its export target to 9.0 million statistical bales, which is just 0.45 million bales more than the 8.55 million bales that have already been committed. 
While we agree with the premise that the US doesn’t have a lot of quality cotton left for sale, we nevertheless believe that export sales will surpass the 9.0 million mark by a considerable margin, since all but 1.1 running bales are now out of the government loan and the holders of this cotton have no other choice but to push it into the marketing channels, if necessary at heavily discounted prices. 
So where do we go from here? The market feels heavy, after the USDA report showed slower US exports and rising US ending stocks, while Chinese reserve auction sales have already moved 1.1 million bales back into the local market. Against this backdrop it is difficult for NY futures to garner any strength, although there is still a considerable amount of trade support underneath the market, stemming from 2.2 million bales in unfixed on-call sales on July as well as a sizeable amount of basis-longs that are going to be sold over the coming months. Considering that the major long in July (held by index funds) is not in play at this point, we don’t see too much downside pressure in the July contract, although a temporary move towards 59 cents is certainly possible. 
New crop futures are a different story, as only a small percentage of Northern Hemisphere crops has been hedged so far. As crops emerge, there will be additional selling pressure from bearish futures and options. We therefore anticipate a range of around 57 – 64 cents for December and March over the coming months, although the weather will play a major role in that!


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