​​​​​​​Market Comments – September 14, 2017

NY futures collapsed this week, as December fell 515 points to close at 69.12 cents.
When it became clear that the impact of Hurricane Irma on the cotton areas of the Southeast would be less severe than feared, the trade started to aggressively sell the market while speculators engaged in damage control on their newly established long positions. 
The result was an epic collapse of over 600 points in just two sessions, as December crashed from Monday’s high of 75.45 to a low of 69.11 cents the following day. The renewed break below the important 7200 support level added to the bearish sentiment.
The latest available CFTC report confirmed that it was massive spec buying that had forced the market higher last week. In just four sessions between August 30 and September 5 (Monday was a holiday), speculators bought 2.55 million bales net as new longs came in and shorts got covered. Specs were therefore 5.58 million bales net long as of Tuesday last week and this position became even larger going into the weekend. 
The trade used this spec-sponsored rally to add short hedges and sold 2.64 million bales net during those same four sessions, boosting its net short to 12.84 million bales as of September 5. We estimate that the trade short has grown to at least 14 million bales by now. 
As if the price action itself wasn’t bearish enough, the WASDE report added insult to injury with even more depressing numbers than in August. According to the USDA global production increased another 3.44 bales to 120.75 million bales, of which 1.21 million bales were added in the US. Since mill use is not keeping pace with this kind of an increase and went up just 0.35 million bales, inventories are expected to become burdensome.
This is especially true for stocks outside of China, as ROW (rest-of-the-world) inventories are expected to shoot up to a record 53.07 million bales, which would be nearly twelve million bales more than the 41.15 million bales of last season and over fourteen million bales more than the 38.52 million bales of 2015/16.
However, we disagree with the USDA on several counts. First of all the US crop number doesn’t include any damage from hurricanes Harvey and Irma yet, therefore this 21.76 million bales estimate is overstated, probably by some 800,000 bales. Australia’s crop numbers for 2017 and 2018 are a combined 700,000 bales too high in our opinion and then there is the Indian ending stocks number, which we believe is at least 5-6 million bales too optimistic. 
We therefore feel that ROW ending stocks will be in the neighborhood of around 46 million bales, which would still be 10-15% more than in pervious seasons, but not quite as depressing as the USDA suggests.
If this sharp stock increase were to materialize, then we could be in for quite a fight on the export front. At the moment the majority of these stocks would have to be carried by producers, merchants or mills and none of them is keen to do so.
The lone exception is India, where the government will start absorbing cotton once prices fall below the Minimum Support Price (MSP). That would kick in about four cents below today’s market. The US has a price support mechanism as well, but at the moment the AWP still calculates over ten cents above the loan. 
So where do we go from here? Interestingly, when we add up production and mill use over the last three seasons, from the 2015/16-season to the current one, we get a combined output of 323.74 million bales vs. a combined mill use of 342.68 million bales. In other words, mill use has been outpacing production by around 19 million bales over those three seasons.
The reason why the market is feeling so weak is because the burden of carrying excess inventories has shifted from the Chinese government to the private industry around the globe. The silver lining in all this is that Chinese reserve stocks will have been cut in half by the end of this season, which means that sooner or later China will become more active again as an importer since it is running a large seasonal production deficit.
When exactly is still up for debate, but given the massive price difference to US futures (ZCE spot is at around 106 cents/lb), it would not surprise us if the Chinese Reserve were to go bargain shopping next spring. In other words, the 5.1 million bales import estimate for China may prove to be too conservative. 
However, in the immediate future prices are likely to come under further pressure as the window for weather related issues is closing. We are not quite at the finish line yet, but the change to warmer weather in the eastern US is promising. Once the crops are in, we could see prices drop to the low 60s, but possibly not before December is off the board. We still feel that the supply bottleneck over the next two months will keep Dec relatively well supported, which should rekindle the Dec/March inversion.


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