Market Comments – October 8, 2015

NY futures rebounded this week, as December gained 112 points to close at 61.72 cents/lb.

US weather concerns, a weaker dollar and some technical factors contributed to the market’s strength this week, as December overcame the 61 cents resistance level and found its way back into the old trading range.

Last weekend South Carolina was hit by a devastating storm, as up to 20 inches of rain fell across the state in a matter of just three days, causing widespread flooding and loss of life. Since only about 10-15% of the cotton crop had been picked before the downpour started, there will be a significant impact on yield and quality. South Carolina was expected to harvest around 420k bales before the storm struck, or about 3% of the US crop.

Neighboring North Carolina was affected as well, although to a lesser degree, with about a third to half of the cotton crop likely to suffer some quality deterioration. There were reports about seed sprouting in the bolls, which will cause spots and discoloration. North Carolina’s crop was estimated at slightly over 700k bales, or about 5% of the US crop.

West Texas got wet as well this week, with most stations receiving 1-3 inches. Lubbock reported a little over 2 inches at the time of this writing and may get some more before the low-pressure system finally retreats tonight. Fortunately the forecast calls for mostly dry and clear weather over the next seven days, with temperatures warming up into the 80s again early next week. This should allow for fields to dry out quickly and for harvest to make some strides.

It will still be several weeks before the bulk of the US crop is finally off the stalk and weather remains a threat based on long-range models, which predict wet and cool conditions for the second half of October/early November. This is one of the reasons why potential short sellers aren’t pulling the trigger at this point, but this might change in a few weeks if the crop escapes major setbacks.

The weakening US dollar was another reason why commodities found some support this week. It all started with last Friday’s dreadful US jobs report, which suggested that only 142’000 new jobs were added last month, much less than the 200’000 the market had expected. Making matters worse, July and August figures were both adjusted downwards by a substantial margin and the labor participation rate fell to just 62.4%, the lowest reading since 1977!

This jobs report may prove to be that watershed moment when the money crowd realized that the US economy is not quite as strong as advertised. This took a potential Fed rate hike for later this year off the table and started to weigh agains a crowed ‘long US dollar’ trade. As a result we have since seen weakness in the greenback, with many of these battered emerging market currencies finally catching a bid.

A weakening US dollar translates into support for commodities, at least in the near term. In the longer run a weak labor market in the US isn’t boding well for aggregate demand and raises the odds for a global recession.

The US export sales report surprised the market with a big number this morning, as net new sales amounted to a combined 568’200 running bales of Upland and Pima for both marketing years, whereof 209’900 were for the current season and 358’300 were for 2016/17. However, upon closer examination traders realized that most of these sales, namely 486’400 running bales or 86%, went to Mexico, while the remaining 15 markets booked just 81’800 running bales.

Total commitments for the current season are now at 3.5 million statistical bales, of which 1.1 million have so far been shipped, while sales for 2016/17 have so far reached 0.6 million bales.

The USDA estimates that Mexico will import 900’000 bales this season, of which nearly all comes from the US. We believe that due the uncertainty in regards to this season’s quality, Mexican mills simply wanted to be proactive and lock in their share of US cotton early on, in order to ensure continuity through the 3rd quarter next year.

Nevertheless, current commitments to Mexico for 2015/16 are already at 856’100 running bales or around 900’000 statistical bales, which is the number the USDA has for the entire season. Since we don’t believe that Mexico is done buying for the season, we feel that the USDA estimate is light and needs to be adjusted upwards.

So where do we go from here? Tomorrow’s USDA report will likely determine the market’s next move! We expect a higher US crop based on early yield reports, somewhere in the vicinity of 13.7 – 14.0 million bales. This should boost global production to slightly over 109 million bales.

We also feel that the USDA is still about 2-3 million bales too high on global mill use. We therefore believe that the difference between global output and mill use is going to shrink further, possibly to less than a million bales. This in turn would mean that we are not going to make much headway in reducing the burdensome inventory level, most of which is still situated in China.

However, even though the statistics may point to lower prices, there are mitigating factors that are acting in support of the market, such as government support programs in the US and India, and a weakening US dollar.

The AWP (Adjusted World Price), which is the price at which loan cotton can be redeemed from the government, has started to move up this week due to higher prices in Pakistan and India. The weekly AWP will be set at 45.22 tomorrow, up 90 points from the previous week, while the daily calculation is even higher at 46.10 cents.

This means that the floor for US prices is moving higher at the moment and this process will only reverse if foreign quotes (Pakistan, India, West Africa) come under pressure again. Based on the AWP and the going rate for loan equities we consider the current futures price at more or less fair value. For prices to move lower we need so see some crop pressure, which is not likely to occur before the crops are in and counted. In the meantime we expect the market to trade sideways in a relatively tight range between 60 and 63 cents.