NY futures were flatlined this week, as December closed the week 20 points lower at 62.32 cents/lb.
It has been an uneventful week in the cotton market, with the spot month closing the last five sessions between 62.13 and 62.76, a very narrow range of just 63 points. The December contract has now been meandering in a 60-68 cents range for nearly fourteen months and at the moment there is nothing on the horizon that would suggest that this situation is going to drastically change anytime soon.
Judging by the depressed mood that currently prevails in most markets, prices should be trading considerably lower than they are. Mills around the globe have been struggling to make ends meet, as cotton prices are basically at the same level as a year ago, while yarn values have come under pressure due to sluggish offtake and cheap polyester prices.
However, as we have pointed out on several occasions, from a statistical point of view one could easily make the case for a stronger market. Over the past couple of months global production has been steadily trending lower, as crops in a variety of origins got scaled back. Due to all the bellyaching about demand it seems that no one has been paying attention to the precipitous fall in production this year.
In 2013/14 the world produced 120.4 million bales and last season it was still 118.9 million bales, whereas we are currently looking at a crop of just 107.4 million bales. Mill use on the other hand, which seems difficult to pin down these days, is still projected to trend higher, from 110.1 million bales in 2013/14 to 110.5 million last season and 112.3 million in the current marketing year.
Many traders, us included, do not believe the current mill use number of 112.3 million bales, which may explain why the market has been so anemic lately. Therefore, let’s assume that the negative sentiment about demand is correct and that mills are going to use five million bales less than the USDA estimate, i.e. 107.3 million instead of 112.3 million bales. Let’s further assume that China’s mill use number is 3 million bales too high and the ROW 2 million.
The reason we have to look at China and the ROW separately is because these two markets have different price levels, which is the reason why China has been a net importer of cotton and yarn in recent years. Although the price gap has been narrowing considerably over the last two seasons, China to date continues to absorb cotton and yarn from the ROW. In fact, the latest import statistics show that China in on pace to take in 2.3 million tons of cotton yarn this calendar year.
If we were to lower ROW mill use by 2 million bales from the current USDA estimate, we would arrive at 76.8 million bales, which compares to 77.5 million last season and 75.6 million two years ago. Considering that economic growth has been slowing in most economies, but yarn exports to China have been increasing this year, we feel that a slightly lower ROW mill use number compared to last year makes sense.
Interestingly, even if we were to lower ROW mill use by two million bales, we would still end up with a ROW production surplus of only 5.3 million bales for the current season. Since Chinese cotton imports are estimated at 5.75 million bales, ROW ending stocks would still be drawn down slightly. In other words, ROW mill use would have to fall a lot more than 2 million bales in order to turn the ROW statistics from supportive to bearish.
The reason the market has not reacted to these somewhat friendly statistics, apart from probably not believing them, is that uncertainty about the future has forced mills into a hand-to-mouth buying pattern. Inventories are being reduced and mills are only buying the absolutely necessary at the moment, pending more visibility. This tends to mask any potential supply tightness down the road, as there is plenty of cotton available to chose from at this point.
US export sales continued to disappoint last week, as just 79’100 running bales of Upland and Pima were sold for the current marketing year, bringing total commitments for the season to 3.8 million statistical bales. Another 6’000 bales were sold for the 2016/17-season, which means that there are now 0.6 million bales on the books for the coming marketing year.
Considering that there were still 16 different markets buying US cotton leads us to believe that a lack of suitable offers and high asking rates are partly to blame for the mediocre performance. Let’s not forget that it was raining in Texas last week and sellers were therefore not in a mood to sell high grades at discounted prices.
So where do we go from here? The market can’t make its mind up, and neither can we! Although sentiment is rather negative, the balance sheet currently points the other direction. Will demand numbers eventually be adjusted downwards as everyone expects? And if so, by how much? Only time will tell!
Speculators have been clobbered recently, first by selling a break below 61 cents and then buy buying the market as it popped above 64. In both instances specs lost money and they probably don’t have much appetite for the cotton market at this point. This leaves it up to the trade, which feels bearish but realizes that adding to an already sizeable short position may not be advisable. We therefore see the market going nowhere in a hurry and expect the current trading range to continue.
As far as the longer-term outlook goes, we shall keep a keen eye on a) the strength of demand, or lack thereof, b) emerging market currencies, which have recently been rebounding and c) potential changes to the Chinese cotton policy that might bring China’s massive cotton stocks into play.
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