Market Comments – September 15, 2016

NY futures were on the defensive this week, as December dropped 157 points to close at 67.72 cents.
The market reacted negatively to the WASDE report on Monday, selling off about 200 points before running into strong support from mill fixations. Since then the market has stabilized and drifted slightly higher, but without much conviction, as today’s lackluster volume of just 11,500 contracts demonstrates.
Volatility dropped considerably this week, with December ‘vol’ dropping about 3% to just a shade over 20%. The skew that existed on out-of-the-money options has also come in considerably, which is a sign that the market doesn’t believe in a big move to either side anymore and is starting to settle for a range-bound market.
The USDA supply/demand report didn’t really contain any big surprises, since the market was already expecting a US crop of more than 16 million bales. Maybe it was the fact that US exports were left unchanged and ending stocks are now projected at 4.9 million bales that scared some traders.
However, when we look at world numbers we feel that the market may not quite appreciate how fast global inventories have been dropping over the last two seasons. At the end of the 2014/15-season, on July 31, 2015, the USDA had global ending stocks at 112.35 million bales, whereof 67.92 million were located in China and 44.43 million in the ROW. December futures traded at around 64 cents at that time.
Now were are looking at ending stock numbers of 89.81 million bales at the end of this season, whereof 50.60 million bales are in China and 39.21 million are in the ROW. In other words, based on current estimates global inventories will have fallen by 22.54 million bales over a 24-month period, which averages to a drop of 939k a month! Granted, 17.32 million bales of this inventory drawdown is occurring in China, whereas ROW stocks are seeing a more modest 5.22 million bales decline.
Actually, we believe that ROW stocks are quite a bit tighter than the USDA leads us to believe, because India did not have 14 million local bales (10.94 million statistical bales) at the end of July. Not according to our research, which is based on several reliable local sources. We feel that inventories are overstated 5-6 million local bales, which equates to around 3.9-4.7 million statistical bales. 
From a global perspective this destocking process could very well continue for another year or two - at least in China - without having any major impact on global cotton prices. But sooner or later either ROW production will have to rise, because China’s output probably won’t, and/or global mill use will have to be rationed. In other words, stock levels can’t continue to decline by nearly a million bales a month indefinitely!
Some of the weakness earlier in the week seems to have been caused by financial market jitters, after the Fed’s Rosengren made some unqualified remarks that the US economy might overheat if interest rates weren’t raised soon. With US GDP growing at just 1.1% in the second quarter and recent economic data (ISM index, productivity, retail sales) all pointing to a recession rather than an expansion, Rosengren’s comment was probably nothing more than a trial balloon to see how markets would react to a potential rate hike. 
Stocks, bonds and commodities didn’t take it kindly, but on Monday other Fed members quickly came to the rescue with dovish statements, after which fears of a “risk off” move by investors started to subside. The markets have since calmed down but this episode has shown how much some these overvalued financial assets depend on cheap, or in some cases free money in order to keep their game going.
US export sales cooled somewhat last week due to a spike in prices, but nevertheless still amounted to 174,400 running bales of Upland and Pima cotton for both marketing years combined. There were 18 markets buying and 19 markets receiving shipments of 131,500 running bales. The low shipment number is due to the fact that the supply pipeline is quite empty at this point. According to EWR there are currently just 1.0 million bales of old crop and 0.6 million bales of new crop available, with 0.7 million bales under shipping orders.
Total commitments for the current marketing year are now at 5.15 million statistical bales, of which a little over 1.1 million bales have so far been exported. With the USDA expecting exports of 11.5 million bales this season, sales are already approaching the halfway mark!
So where do we go from here? The CFTC report of last week showed that the recent price spike was mainly due to spec short covering rather than new spec buying. As pointed out before, specs are already 8.3 million bales net long and therefore don’t have as much firepower to force the market higher. Even if speculators were to buy another 3-4 million bales net, grower selling would probably be there to absorb it now that the crops are about to move in.
The downside seems equally contained, since there are about two trade shorts for every spec long and with mills still needing to fix and buy a lot of cotton in the weeks and months ahead, it would take an outside event to generate enough spec pressure to chew through all this underlying trade buying. We therefore feel that the market will remain range-bound in the foreseeable future, somewhere between 66-71 cents.



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