NY futures came under heavy pressure this week, as December dropped 363 points to close at 63.35 cents/lb.
The market gave back nearly all the gains that it had accumulated since the USDA report on August 12, as newly established spec longs got spooked out of their positions by financial market jitters.
The latest CFTC report, which encompasses the period from August 12-18, shows that speculators had loaded up after the crop report by adding 2.82 million bales net to their long holdings. Index Funds increased their net long as well, adding around 0.15 million bales, whereas the trade was selling into the rally, boosting its net short by 2.97 million bales.
However, when stock markets around the globe went into free fall last Friday, the tide quickly turned and speculators started exiting their long positions in a hurry, judging by the sharp drop in December open interest. Over the last three sessions, between Monday and Wednesday, open interest in December dropped by a total of 1.66 million bales, as speculators dumped longs while the trade covered some shorts along the way. With financial markets calming down again, the ferocious spec selling finally stopped, allowing for a slight rebound in today’s session.
As we have already reported on a couple of occasions, there have been massive currency devaluations in emerging markets this year due to capital flight, which make it more difficult for importers to pay for dollar-denominated assets. For example, the Turkish Lira is down 33% vs. the US Dollar over the last twelve months, the Mexican Peso 27% and the Indonesian Rupiah is off by 17%.
China is so far the only emerging market currency that hasn’t collapsed against the US dollar. In fact, despite the small devaluation of a few weeks ago, the Chinese yuan is still over 6% stronger against the greenback when looked at over a five-year period. However, with all the currencies around it collapsing, China doesn’t seem to have any choice but to give up the US Dollar peg and move to a more market-driven rate.
Here are just a few examples of how much the Chinese currency has appreciated vis-à-vis some other currencies over the last five years: Euro (22%), Indian Rupee (49%), Japanese Yen (56%), Turkish Lira (103%), Brazilian Real (115%) and Russian Ruble (132%). Given the deteriorating economic conditions and increasing capital outflows, we believe that it will only be a matter of time until the Yuan continues to play catch up with these other currencies.
If it does, it will have implications for the cotton market, because it will bring Chinese cotton prices further down and possibly close the remaining gap to the international market. Chinese cotton and yarn imports in recent years were driven to a large degree by the huge price difference that existed between China and the ROW (rest of the world).
A year ago this price gap was still at around 40 cents/lb, but since the Chinese domestic price has fallen from around 17’000 to 12’000 Yuan/ton since last summer, the price difference has narrowed dramatically. Today the spot contracts in the ZCE and CNCE markets amount to only around 85 cents/lb, which is more or less the same value as US high grades landed China, based on a one percent import duty and 13% VAT.
Therefore, if the Chinese currency continued to devalue, to let’s say to 7.0 Yuan/USD from the current 6.4 Yuan/USD, it would bring Chinese cotton prices down by another 9-10 percent. Since China is currently sitting on around 14.5 million tons of inventory, according to the latest USDA numbers, a lower price ceiling would probably make it all but impossible for international prices to rally in the foreseeable future and it would also render yarn exports to China less profitable.
US export sales for the week that ended on August 20 amounted to just 63’300 running bales for the current marketing year and 20’500 running bales for 2016/17. However, there were still 15 markets participating, with Colombia accounting for the lion’s share with 17’400 running bales. Shipments of 109’000 bales were slow, but that had to be expected considering that stocks are nearly exhausted and new crop isn’t available in any volume yet.
For the season we now have total commitments at 2.8 million statistical bales, of which just a little over 0.3 million bales have so far been exported. Sales are lagging 2.4 million bales behind those of last year, with China and Turkey accounting for the majority of the shortfall. So far these two buyers are on the books for just 0.41 million statistical bales combined, which compares to 2.08 million bales a year ago!
So where do we go from here? Since speculators have just taken a beating by this seesaw market, they are probably not in any big hurry to enter the long side again. The trade isn’t chasing values either, since mills are not willing to pay the current asking prices. On the other hand the downside remains contained by the uncertainty surrounding the US and Indian crops, which are still vulnerable to adverse weather, and the limited availability of spot cotton in the pipeline. In other words, we are still in a waiting game as the market remains confined to a 61.50 to 68.00 range, which will have its anniversary in about three weeks from now.