NY futures didn’t move much since our last report of two weeks ago, as March added just 40 points since November 15, closing today at 78.68 cents.
The market reminds us of a tiger pacing back and forth in a tight cage, as March had seven alternating up-and-down sessions and has settled the last 13 sessions in a narrow range of just 166 points, between 77.22 and 78.88 cents/lb. When we zoom out a little further, we notice that March has closed the last 52 sessions in a band of just 463 points, between 76.82 and 81.45 cents/lb.
The market seems to be fairly well balanced at this point, with the current price level making sense from a fundamental point of view. Global production has taken a small step back, mainly due to reductions in the US, China and India, but global demand seems to have dropped by an even bigger margin, thereby greatly reducing the seasonal supply gap.
The USDA is still showing a 7.49 million global supply gap for the current season, but we believe that the real deficit is not even half of that. Also, ROW ending stocks are expected to rise to 44.58 million bales by the end of this season, which would be an increase of 10.10 million since July 2017. And this increase will be a lot higher if we are right on the smaller production gap.
Although there is no shortage of cotton this season, the world’s largest exporter, the US, is once again experiencing quality issues, which is giving shippers plenty of headaches. Last season it was an abundance of low mike cotton that depressed the cash basis for such qualities vis-à-vis loan discounts and caused painful losses to shippers.
This season the fiber quality of the crop is generally quite good, with staple length at 36.7 and a mike average of 4.4, but wet and stormy weather has lowered the average color grade of the US crop considerably. As of November 22 there have been 7.7 million running bales classed, of which only 36% had a color grade of 31 or better, while 75% were 41s or better. These percentages are likely going to drop as the balance of the crop gets classed, since there was a lot of adverse weather hampering the second half of the crop.
By comparison, last year’s crop yielded 67% of 31 or better grades, or nearly twice as many as this season. The percentage of 41s has nearly doubled compared to the last two seasons, when it amounted to just 20 and 21%, respectively. The same goes for qualities that are lower than 41, which are so far at 25%. That’s much higher than the 10.2% in 2016 and the 11.8% in 2017. Again, these percentages will likely get worse as the remainder of the crop moves in.
Last season the entire Upland crop of 19.8 million running bales produced just 310k bales of 42s and 64k bales of 52s. This year, with only 7.7 million running bales classed so far, we already have 705k bales of 42s and 175k bales of 52s, and there is a lot more to come.
So in a nutshell we have a situation in which a) there is a shortage of 31 and better qualities to make shipments against high priced forward sales, b) there is an abundance of 41s, for which there exists at least the possibility to dump it on the certified stock and c) there is a large amount of 42s, 52s and other low grades, for which there is no other option but to sell it as quickly as possible into the marketplace.
This has led to interesting dynamics in the cash market, as 42 style cotton is being pushed at steep discounts, while the basis for top grades is firming. 41 style cotton seems to be caught in the middle, as it is too expensive when compared to 42s, yet it can’t be used to meet high grade commitments. Therefore a lot of that stuff may end up in the certified stock, which in turn should keep a lid on the futures market.
US export sales of 212,300 running bales for both marketing years were quite decent last week, as merchants were pushing some of these discounted lots, with Vietnam, Pakistan and India being the best takers. Shipments are still slow at 135,900 running bales, as L/C openings are lagging and merchants struggle to find the right qualities to ship. For the season we now have commitments at 10.4 million statistical bales, of which only 2.7 million bales have so far been exported. Sales for next marketing year are at just over 2.0 million statistical bales.
So where do we go from here? From a fundamental point of view we see no reason for the market to rally. There is plenty of cotton around at the moment and the fact that we have such a large amount of tenderable 41 style cotton should keep a lid on the market. It would help if China were able to come back into the market to absorb some of these lower qualities, which is why traders are keenly awaiting the outcome of the US-China trade talks at the G-20 meeting this weekend.
A positive development on the trade front would probably lead to a relief rally, but we don’t feel it would amount to much more than another flash-in-the-pan, although a break through trendline resistance might give the market an extra boost. On the other hand, if talks fail to meet the high hopes of the market, a test of the recent lows would be the likely consequence.
Support at 75-76 cents seems quite solid at the moment, especially since the CCI has started to support the Indian market via its Minimum Support Price (MSP) mechanism. In order to break through support it would take more bad news on the economic front, which we don’t rule out.
Although a breakout to either side is now entirely possible based on the technical picture, we still feel that cotton is fairly priced at the current level and that any such breakout would be relatively short-lived.
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