Market Comments – October 25, 2018

NY futures closed a rollercoaster week nearly unchanged, as December gave back 37 points to close at 77.68 cents.

The best way to describe the current market is as ‘schizophrenic’. As explained last week, traders don’t know what lead they should follow at the moment - a friendly supply scenario or the negative vibes coming from the global financial markets, which might put a damper on demand.

December covered a range of exactly 400 points over the last five sessions, from Monday’s high of 80.14 to today’s low of 76.14 cents. The week started great for the bulls, as traders returned mostly encouraged from the ICA Dinner and lifted the market to a close of 80.02 on Monday. But it was all downhill from there, as a falling US stock market raised doubts among traders and dragged the commodity complex down with it.

The S&P 500 index had six straight losing sessions for a total drop of 5.45%, before it bounced slightly today. The Dow and S&P 500 are about flat for the year, while the Nikkei is down around 7%, the FTSE in London is down 9% and the Chinese stock market is down around 20%. In dollar terms all outside stock markets are now down for the year. This raises concerns about a ‘negative wealth effect’, which would likely crimp demand as consumers start to feel poorer.

The world has enjoyed a long bull ride thanks to ten years of ultra-cheap money, but as the cost of capital increases in a necessary move to contain looming inflation, it puts the brakes on a further expansion of asset bubbles and may force economies into recession.  

The S&P 500 chart looks quite ominous at the moment, as we have broken below the primary uptrend line dating back to February 2016. If the market doesn’t continue to recover on Friday and we get a weekly close below this important uptrend line, it will likely spark another round of selling.

While the demand side looks ‘iffy’ with all the uncertainty on the economic front, the supply side has its problems as well. Not only has the US crop lost about a million bales to two storms, but there has also been a lot of rain in the Mid-South, South Texas and most recently in West Texas.

The latest classing report reflects these weather problems, as the first 2.7 million bales classed have only yielded 64% in tenderable grades. The first 1.1 million bales in the Mid-South produced only about 31% Middling or better. The Southeast has just 0.22 million bales classed so far, which were harvested before the two hurricanes hit, and most of what comes after that will likely be of inferior quality. West Texas remains the biggest hope for a sizeable chunk of high grades and after some more rain earlier this week, it looks like there are finally going to be some sunnier days ahead. Fingers crossed!

When we did a back-of-the-napkin calculation on how many tenderable grades we might expect from this crop, we came up with a number of around 9.5 million bales. Against that we have US export and domestic commitments of 13.2 million statistical bales for shipment until July 2019, plus an estimated 2.0 million bales that will be shipped from current supplies in the August/October 2019 period. We therefore believe that it will be quite challenging to match up the quality of this crop with existing commitments.

One redeeming factor is that the staple length (36.5 average) and the micronaire (4.6-4.7 average) are so far promising. This should allow for discounted cotton to find some interest once these overs become available.

US export sales of Upland and Pima cotton remained slow last week, as just 56,600 running bales net were added for both marketing years. China cancelled 37,900 bales and even Vietnam reduced Upland sales by 2,800 bales, although overall it was still a net plus as it added 4,400 bales of Pima.

Shipments remained seasonably slow at 144,300 running bales. For the current season we now have commitments of 9.8 million statistical bales, of which 2.0 million bales have so far been exported. For the 2019/20-season there are so far a little over 1.8 million statistical bales on the books.

So where do we go from here? It’s a tough call at the moment, because the cotton market is not really in charge, but relies to a large degree on what happens in the outside markets. Speculators have been selling over 9 million bales net since early June and they may not be done yet. They are probably down to a net long of around 2.5 million bales by now, but the last time we had the threat of a recession, in early 2016, speculators went to a 4.4 million bales net short position and the market traded in the mid-50s.

If the US stock market continues to sell off, which we believe it will, cotton is likely going to get dragged lower as well, since traders will start to price in a recession. On the other hand, if financial markets were to stabilize and rebound, then there are plenty of fundamental reasons why cotton prices should move back above 80 cents.

The Dec/March spread started to eat away carry again today, after it moved out to 180 points yesterday. This may be a sign that some takers are beginning to show interest, as they can take delivery of December with a decent amount of carry, pick out the better grades and then deliver the rest back onto March. With shippers scrambling for early premium grades and the high grade basis likely to strengthen in the US, December should see ‘relative strength’ from here on forward. 

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