NY futures continued to advance this week, as December gained another 172 points to close at 63.44 cents/lb.
Supportive fundamental and technical factors lifted the market to its highest level in nearly eight weeks, as December caught up to its long-term moving averages, with today’s close falling between the 50-day (62.73) and the 200-day (64.14) MAs. With the benefit of hindsight it now looks like the market’s recent break below 61 cents simply extended the 13-month sideways trend by a cent to 60-68 cents, but failed to open the door to a lower price plateau.
Last Friday’s WASDE report set the stage for the market’s advance this week, as it came in slightly more friendly than the market had anticipated. While the 1.17 million bales drop in global mill use to 112.27 million bales was expected, the market was somewhat surprised that global production was cut by an even larger amount, dropping 1.36 million to just 107.38 million bales. Crop estimates were lowered for China (-700’000 bales), Pakistan (-500’000), Brazil (-200’000), Australia (-100’000) and the US (-90’000), while West Africa bucked the trend with a 330’000-bale increase.
Despite a 2.4 million bales reduction in global mill use over the last two reports, the ROW (rest of the world) balance sheet continues to suggest that ending stocks will tighten by nearly 2.2 million bales at the end of this season. On August 1st we started with an inventory of 43.87 million bales outside of China and based on the latest USDA estimate this number is going to shrink to just 41.70 million bales by the end of July. This is due to the fact that the ROW production surplus of 3.31 million bales will be more than offset by Chinese imports of 5.75 million bales.
The disappointing performance of crops around the globe is slowly but surely lifting the global price floor, as higher local prices in the Indian Subcontinent as well as some other markets are having a direct impact on the AWP (Adjusted World Price) and therefore the US market.
Pakistan’s crop seems to have suffered a major setback from either pest attack and/or mismanagement, with the US Ag attaché this week estimating production at just 9.2 million statistical bales or about a million bales less than two months ago. This has caused a sharp rally in the local market, with some mills even turning to imports from India and West Africa.
Just a couple of weeks back, on October 1st, the Pakistan T.1503 quote was the cheapest in the AWP calculation at 61.00 cents, but it has since increased to a nominal value of 66.50 cents. Because quotes for Indian and West African Middling styles have also gained 325 to 350 points over the last two weeks, the AWP has seen a rather significant jump from a daily value of 44.05 cents on October 1st to 47.90 cents today. The official AWP value, which is based on a weekly average, has moved up from 44.32 cents two weeks back to 46.70 cents for the week starting tomorrow.
Since a higher AWP translates into a lower “Loan Deficiency” or “POP” payment, growers are trying to compensate for this opportunity loss by demanding higher “equity” values on their loan cotton. This means that US prices are currently being impacted on two fronts, as both the AWP and “equities” are trending firmer.
Based on the current AWP and the going rate for equities, we consider the “fair value” for spot futures to be at around 63-64 cents. In order for prices to move lower, we would therefore either need to see the AWP decline again and/or equity demands to be lowered, which seems unlikely in the near future. Lower crop estimates and a weaker US dollar have been underpinning local prices in Pakistan and India lately, while West African styles are encountering stronger demand as a result of problems elsewhere.
So where do we go from here? From a fundamental point of view the stronger market is reflecting a higher AWP + equity value, as well as a weakening US dollar. From a technical point of view the market’s ability to take out resistance near 62.50 has prompted a wave of short covering, with December now trying to overcome long-term resistance in the 64 cents area. If successful, a further push towards 66-67 cents cannot be ruled out.
However, timing-wise any further advances are likely to run into trouble, because we are only a little over five weeks from entering the December notice period, at which time the futures market will have to reconcile with the cash market. Since most mills around the globe are so far not willing to adjust their price ideas to the current level of the futures market, the board may become the highest bidder for US cotton, especially when it comes medium and lower qualities. Remember, NY futures allow 41s and 51s to be delivered, with a minimum 33 staple length. Therefore, if US weather continues to cooperate and the crop moves in fast, we expect a lot of odd qualities to find their way to the cert. stock by late November.
Although we may see additional price spikes based on spec short covering and new fund buying, mill demand still doesn’t look promising and for this reason we can’t get overly excited at this point. We therefore continue to see the market in a slightly higher sideways range between 61 and 65 cents in the foreseeable future.