Market Comments – September 13, 2018

NY futures closed a volatile week basically unchanged, as December edged up 21 points to close at 81.51 cents.

Even though December posted its highest close in four weeks on Monday, it was unable to maintain any upside momentum and then quickly fell back to its starting point. December has now settled the last 23 trading sessions in a very tight band of just 311 points, between 80.74 and 83.85 cents.

Hurricane Florence was the main feature in the market this week and it was getting some traders bulled up early in the week when it looked like it would strike the Carolinas as a Category 5 storm. However, it has since been downgraded to a Cat 2, which is still a powerful system, but clearly not as devastating as feared. There is still be a lot of rain coming to the cotton areas of North and South Carolina, where crops are probably about 50-70% open by now.

The consensus seems to be that there could be losses of up to 200k bales, with another 300-400k possibly seeing some quality downgrades. But in the big scheme of things this isn’t expected to have a major impact, especially since most other crops in the US and around the globe are looking quite promising.

Yesterday’s WASDE report showed a 1.44 million bales increase in global cotton production, of which 0.45 million came from the US. Although global output of 121.97 million bales would be the 5th highest on record, it would still be 1.51 million bales less than last season, when the world produced 123.48 million bales.

The USDA also continued to increase global mill use by 0.32 million bales to 127.94 million bales, which would be a new record. The most the world has ever used in a single season were 124.21 million bales in 2006/07. Since then global population has grown by 927 million people and it would therefore seem logical for cotton consumption to be a lot higher.

But cotton’s market share has declined from about 36% to just 25% since then and has only recently started to make a bit of a comeback, which combined with stronger economic growth has boosted mill use over the last two seasons from 116.12 million bales in 2016/17 to 123.22 million bales last season, with another 4.72 million bales increase projected for the current season.

Given the recent turmoil in some of the emerging markets, many traders have become skeptical of this optimistic consumption number, which seems to be the main reason behind the market’s soft tone of late. If mill use were to reach nearly 128 million bales and thereby eclipsed production by six million bales, then the market would certainly have a firmer appearance.

When we look at stock numbers, we notice that ROW inventories are down 0.87 million bales from last month to 47.59 million bales, which would however still be 1.82 million bales more than last season. Meanwhile China continues its rapid destocking, with the current estimate of 29.87 million bales being 8.15 million bales less than last season and 16.05 million bales fewer than two years ago.

Thanks to a bumper crop China seems to have bought itself some time before it has to revert to more imports, which is another reason the market has been on the defensive lately. Many traders expected this inflection point to arrive sooner, perhaps as early as next spring, but now it seems that the timeline has been pushed back by some 6-12 months.

US exports continued at a slow pace last week, as just 105,200 running bales of Upland and Pima were sold for both marketing years. Shipments of 138,500 running bales were equally uninspiring. However, with 9.4 million bales in commitments, merchants seem to be reluctant to add more sales at this point, especially with storms threatening to reduce the availability of premium grades.

So where do we go from here? The market still seems to be trapped between strong support and resistance areas. With unfixed on-call sales still at 14.97 million bales as of last Friday, of which 3.71 were on December, there is still a strong layer of support underneath the market.

However, the market is getting close to some important technical support, the 80.65 low of this five-week sideways range and then the important 200-day moving average at 80.30. A break below these levels would likely flush out a decent chunk of the remaining spec long. The good thing is that the spec net long is not nearly as powerful as it was a few months ago, since is measured just 6.7 million bales last week. We therefore feel that any spec selloff should be readily absorbed by trade fixation buying, although this doesn’t mean that the market couldn’t temporarily dip into the mid-to-high 70s.

The long-term fate of the market depends on demand. If mill use gets anywhere close to the USDA estimate, then prices will eventually rebound, but the more likely scenario is slowdown in demand due to various emerging markets experiencing recession. This would reduce the supply gap and thereby keep inventories stable. Prices would probably remain range-bound in such a scenario.

For now we assume that the market is going to hold support and that the current sideways range will continue for a while longer. 

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