NY futures ended a volatile week basically unchanged, as March moved up just 40 points to close at 79.08 cents/lb.
Although March broke above its long-term downtrend line dating back to early June, it was unable to generate much upside momentum. Speculators sponsored the rally on Monday by buying back shorts and adding some new longs, but the trade was a keen seller, which capped the advance and eventually forced the market to retreat.
March failed to make new intra-day or settlement highs during this move, which means that the front month has now been in a 463-point closing range between 76.82 and 81.45 cents for the last 57 sessions, dating back to September 18.
Last week we talked about the primary reason why the market is unable to rally at this point in time, namely the abundance of SLM-style tenderable cotton. When we look at the daily classing sheets from this week and further take into account that the tail end of the US crop encountered difficult weather conditions, we estimate that around 45% of the crop will be of 41 colour and some 27% percent will be lower than that.
On an Upland crop of around 17.5 million running bales this would equate to roughly 7.9 million running bales of 41s and 4.7 million bales of grades lower than that, for a total of 12.6 million bales. Since the fibre characteristics are quite good, it is not necessarily a question of who will buy all this cotton, but when and at what price?
There is plenty of cotton and yarn inventory at the moment and China is still absent as a strong importer, so we don’t expect mills around the globe to start chasing after these 41s anytime soon. Therefore, since a lot of these grades are tenderable - 66% out of 9.1 million bales classed so far - the NY futures market has emerged as the top buyer, attracting some of this cotton to the board every time it lifts its head. Although the certified stock is still relatively small at 140k bales, it has the potential to grow substantially if the futures market pays a better price than the cash market.
In order for the market to eventually move higher, it needs to remove this low grade obstacle first. Either prices have to drop low enough for mills to want this cotton or the board has to build full carry to entice takers to hold on to this growing certified stock. Neither of these two conditions is in play yet. The 41-4-36s, which will probably make up the bulk of the certified stock, are still a bit pricey at 80.25 cents FOB truck (March 79.08 cents + 1.17 cents premium for 36 staple).
As for carrying charges, if we take full carry at 85 points/month, then the current March/July spread of 204 points is not wide enough yet. Then there is the July/Dec spread, which is 364 points inverted at the moment. It is still too early to know how the situation is going to look like six months from now, but if there are still plenty of these 41s left by next summer and they need to be carried into the 2019/20-season, then a lot could happen with this July/Dec spread, as it might move from inversion to carry.
The silver lining of having these lower qualities is that if they are attractively priced, a lot of them will move, which would boost export sales and lead to tighter ending stocks. With the Australian crop being smaller this season and with Brazil facing logistical constraints, it seems that there is no way past the US and that mills will have to find a way to deal with these lower qualities.
Although the G-20 meeting ended on a slightly more optimistic note in regards to the US-China trade issue, it is far too early to tell whether the two countries will be able to work out a deal by early next year. There have been plenty of rumours this week about China intending to boost imports of various US Ag products, including cotton, but so far we haven’t seen anything concrete.
The uncertainty on the trade front and signs of an economic slowdown have once again pressured financial markets this week, with the US stock market testing its October lows today, while several European stock indexes have slipped into bear territory. Although the US stock market managed to bounce back strongly going into the close, we are now in a much more uncertain and volatile environment than three months ago. This growing “risk off” attitude is being felt in many markets around the globe, including cotton!
So where do we go from here? The abundance of lower US qualities and softer financial markets are keeping a lid on cotton at the moment. However, with crops around the globe not living up to their expectations, both in size and quality, there is currently not much price pressure building. We therefore see no reason for the market to leave its current range of roughly 77-82 cents, which it has occupied since mid-September.
In order for prices to move higher, we need to see stronger export demand, which doesn’t seem to be in the cards at the moment. This would change if the US and China were to work out a trade deal, but this is probably still 2-3 months down the road.
Conversely, a break to the downside might happen if financial markets continued to sell off and if we had confirmation of a global recession. At the moment there are still plenty of optimists out there and with the Fed changing its stance back to ‘accommodating’, the worst case scenario doesn’t seem to be in play just yet.
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