NY futures traded in volatile fashion since our last report of July 30, with December closing the two-week period 224 points higher at 65.79 cents/lb.
A couple of days ago it looked like the market was about to fall apart, when December traded to a new contract low of 61.20 cents shortly before the release of the WASDE report. Sluggish mill demand, a dismal looking chart and macroeconomic concerns seemed to make it a foregone conclusion that the spot month would eventually break below the 60 cents level.
However, when an unexpectedly bullish USDA supply/demand report caugh traders on the wrong foot, the market quickly reversed course, with December briefly touching limit up on Wednesday before settling 349 points above the low of the day. The resulting key reversal was furthermore validated by massive volume of over 62’000 futures and 25’000 options, with Thursday’s follow through session seeing another 53’000 futures and 29’000 options changing hands.
The USDA report, as presented, is unequivocally bullish, since according to the government the ROW (rest of the world) production surplus is expected to drop to just 2.34 million bales in 2015/16, which is 2.18 million bales less than a month ago. By comparison, in 2014/15 the ROW still produced a surplus of 11.18 million bales and in 2013/14 it amounted to 12.15 million bales!
Since Chinese imports were left unchanged at 5.75 million bales, the USDA numbers suggest that ROW ending stocks will be drawn down from 43.83 million bales in 2014/15 to just 40.61 million bales by the end of this season. This would be a number comparable to the 40.35 million bales we had two seasons ago, when international prices were around 20-25 cents higher.
However, before we turn into raging bulls we need to examine these latest USDA numbers in greater detail. This conspicuous drop in the ROW production surplus stems mainly from a sharp cut in US production and an increase in ROW mill use. While anything is possible, we struggle to understand both of these changes.
Looking at US production, the government lowered its crop estimate by a whopping 1.42 million bales, from 14.5 to 13.08 million bales, with most of this reduction occurring in Texas, where a crop of only 5.3 million bales is expected. This shockingly low number is the result of fewer planted acres (5.1 million acres vs. 5.2 in the June report), of which only 4.2 million acres are expected to be harvested due to a large abandonment of around 18%. Adding insult to injury, the USDA also cut its yield estimate to just 606 lbs/acre, which compares to 644 lbs/acre last season.
We are quite skeptical of this pessimistic view on Texas. Sure, the hot and dry weather that Texas has experienced in recent weeks may have taken its toll on some parts of the crop, particularly dryland acreage, but there has been no indication that this year’s crop should come in worse than last year’s in terms of yield, especially when we consider that nearly a million abandoned acres are taken off the balance sheet.
Turning to ROW mill use, we disagree with the government’s 80.65 million bales for 2015/16, which would be 2.85 million bales more than in the season that just ended and 5.1 million bales more than in 2013/14. Considering that we are in the midst of an emerging market crisis, we are a lot less optimistic on mill consumption, particularly in markets like Indonesia and Turkey. While the USDA maintains Indonesia’s mill use at 3.4 million bales, our sources tell us that a more realistic number is probably 0.6 million bales below that. Since several other markets are reporting similar conditions, we believe that we would be lucky to see ROW mill use at more or less the same level as last season!
Only time will tell, but if the US crop came in closer to 14 million bales and ROW mill use were to remain at par with last season, it would bring the ROW production surplus closer to 6 million bales, or about the level of Chinese imports, which would leave ROW ending stocks basically unchanged.
US export sales for the week that ended on August 6 amounted to 96’900 running bales net, with Vietnam once again leading a pack of 15 different buyers. There were a total of 489’900 running bales carried over from last season, which means that total commitments for the current season amount to around 2.7 million statistical bales, of which just 0.1 million bales have so far been exported.
Last year commitments were about 2.0 million bales higher at this point, but with a crop that is expected to be 3.2 million bales below that of 2014/15, the amount of available US cotton would actually be over a million bales smaller than a year ago.
So where do we go from here? Whether one chooses to believe the current USDA numbers or not, they have certainly put enough doubt into traders’ minds that we don’t expect to see any selling pressure until the outcome of the US and other major crops is known. While it has been relatively calm on the US weather front in recent weeks, apart from too much heat in Texas, we expect stormy and wet weather to return in September. The long-range forecast calls for a potentially challenging harvest in Texas and the Mid-South, which should keep the market on edge.
From a technical perspective the market has possibly put in a significant bottom with Wednesday’s key reversal. Much of the downside pressure we saw in recent weeks has come from new spec shorts, which are now forced to cover. Along with some new spec and trade buying this could force values into the high 60s and challenge the upper end of the 61.50 to 68.00 cents trading range. However, growers are behind the curve in selling and/or hedging their crops and will likely use any further strength to sell into. Only as the supply/demand picture becomes more defined over the coming months will we find out whether the market’s newfound strength is justified or not!