NY futures rebounded this week, as March gained 202 points to close at 72.85 cents/lb.
On December 12 the market was still trading above 80 cents, but in the three weeks that followed the spot month fell precipitously, losing over 900 points before the slide finally stopped at a low of 70.65 cents on January 3. Clearly the market had been too expensive to attract much cash business and it didn’t have enough carry to entice longs to hold on to cotton, so a dive was necessary in order to rectify the situation.
The price correction seems to have worked, as mill demand has improved considerably over the last two weeks, judging by the reports we are getting from traders and mills in the absence of any government data. It was primarily the Indian Subcontinent (Pakistan, India and Bangladesh), along with a few Far Eastern markets, that have stepped up to the plate.
Additionally we have seen the March/May spread go from 104 to 151 points carry since December 12, thereby providing more incentive for merchants to hold on to inventory rather than dumping it. The more carry there is, the less urgent it becomes to dispose of stocks, which is providing some stability, especially as the pile of unsold cotton is being reduced over the coming months.
As we have stated last week, the US doesn’t have much competition near the 70 cents level. This is quite evident when we look at India, which traditionally is one of the strongest competitors on the export front. This week the Cotton Association of India not only revised its crop estimate down further, to 33.50 million local bales, but it also lowered net exports to just 2.4 million local bales, which compares to 5.1 million bales last season.
Since US prices are now at par or cheaper than Indian cotton, we have witnessed a surge in buying by mills on the Indian Subcontinent, which has provided strong support at around the 71-72 cents level. The most bullish scenario for the US in the long run is for prices to remain low for another two or three months, in order to clean out as much of this SLM-style inventory as possible.
Brazil has emerged as a force on the export front in recent months, partly because of its bumper crop of over 11.0 million bales and partly because its ability to ship out cotton has vastly improved. In December Brazil shipped a record 214,590 tons or nearly 1.0 million statistical bales, bringing its six-month total to 679k tons or 3.12 million statistical bales.
China has been by far the best buyer of Brazilian cotton since July, accounting for 279k tons or 1.28 million statistical bales. That’s over 200k tons more than during the same period a year ago. It is rumoured that the Chinese Reserve has been behind some of this volume. The fact that China is absorbing so much Brazilian cotton is supportive to international prices in our view, since it reduces available supplies for the rest of the world.
There are currently plenty of rumours going around about the latest trade negotiations between the US and China. According to some sources China is apparently agreeing to import more US Ag products at either no or very low tariffs, including 1.0 million tons of cotton.
There is nothing concrete yet and it could all be just wishful thinking, but we feel that it is in the interest of both countries to come up with a trade deal fairly soon. Importing more Ag products makes a lot of sense for China, because it isn’t self-sufficient when it comes to food and in regards to cotton it won’t be able to supply its mills from reserve stocks for much longer.
So where do we go from here? The market actually makes some sense to us at the moment. At 71-72 cents the futures market gets competition from the cash market and therefore doesn’t need to go any lower. However, when it rises to 73-74 cents, like it has been doing a few times since Christmas, the board becomes the top buyer again and therefore attracts selling by the trade.
The wild card in all this is China. If a trade agreement is reached in which China agrees to buy more cotton, the market would probably spike a few cents, possibly even back towards the 80 cents level. But intentions alone won’t do and eventually traders want to see evidence that China is back in the US market. Nevertheless, short sellers are probably going to remain on the sidelines until we know more, which has lifted some pressure off the market.
In summary, we feel that there is not much downside risk at the moment and as US cotton continues to sell and inventory levels come down, the market will eventually reflect that by moving higher. A trade agreement with China would simply act as an accelerant in this process.
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