NY futures continued to slip this week, as December gave up another 59 points to close at 62.76 cents/lb.
It was an uneventful week in the futures market, with December closing the last five sessions in a very tight band of just 51 points, between 62.49 and 63.00 cents. Daily volume has been averaging just around 17’000 lots and open interest continued to shrink by another 2000 contracts.
The market’s lackluster trading action is a reflection of the continued standoff between growers and mills. With the outcome of the Northern Hemisphere crops still uncertain at this point and government support in the US (loan) and India (MSP) providing a safety net, growers are in no hurry to let go of their cotton at current prices. Mills on the other hand are facing a margin squeeze due to weak end-user demand, cheap polyester prices and depreciating currencies, which has forced them into selective hand-to-mouth buying.
From a statistical point of view a range-bound market still makes sense at the moment, because in its August report the USDA predicted the ROW (rest of the world) production surplus at only 2.3 million bales, which would be less than Chinese imports of 5.75 million bales. In other words, the current statistics imply a tightening of ROW stocks this season, which would argue for higher prices.
However, since most traders are not in agreement with the USDA, especially when it comes to the size of the US crop and the government’s overly optimistic view on mill use, the ROW production surplus could end up being several million bales larger than 2.3 million bales. For example, if the US crop were to come in at around 14.0 million bales and ROW mill use were lowered by 3% to 78.0 million bales, to the same amount as last season, then the ROW production surplus would jump to 5.3 million bales and more or less match Chinese imports.
We therefore need to be careful about how we manage our expectations for next Friday’s USDA report. If the above assumptions were to materialize, then a ‘bearish’ WASDE report would simply serve to neutralize the current bullish statistical picture. In order for the statistics to actually turn bearish, it would require a much more pronounced drop in global mill use than 3%.
Given the tough macro environment this is certainly a possibility. We feel rather strongly that mill use is not anywhere near the numbers of the USDA (114.7 million bales) and the ICAC (115.0 million bales). Cotlook’s estimate of 110.0 million bales seems to be a lot closer to reality, but if the emerging market crisis were to get worse, we might see an even lower mill use number. In other words, we are still very much in limbo and only time will tell where the truth lies.
The same goes for production, although there is not nearly the as much disagreement between the three entities. The USDA (109.0 million bales) and ICAC (108.9 million bales) are both slightly more optimistic on production than Cotlook, which currently carries a 107.3 million bales estimate. The US and India, which account for about 45% of global cotton exports, have the highest degree of uncertainty at this point, because they are both impacted by an unusually strong El Niño this season.
Although a hot summer has allowed a late-planted US crop to catch up, it still has to navigate through a potentially stormy and cool fall over the next 4-8 weeks. On the other side of the globe, India has been struggling with an uneven monsoon and some pest attacks this season, which has prompted traders to scale back their crop expectations. Nevertheless, the current USDA forecast of 29.0 million statistical bales (37.1 million bales of 375 lbs) still seems within reach at this point, but with the Monsoon expected to withdraw over the next week or two, estimates may have to be scaled back further.
US export sales were once again nothing to get excited about at 73’800 running bales for Upland and Pima combined. There were still 13 markets in the mix, with Vietnam once again leading the pack. Total commitments for the season now amount 2.9 million bales, of which 0.5 million have so far been shipped.
So where do we go from here? From a technical point of view the market is still very much confined to a 61-68 cents sideways range, which had its origin nearly a year ago. Long-term moving averages from the 50- to 200-day are flatlined and neatly bunched together between 64.50 and 65.00 cents. Speculators seem to have disengaged for now, with the trade dictating the little action there is.
From a fundamental point of view there are a lot of crosscurrents at the moment, which make it difficult to get a good handle on the market. On the bullish side we have potential threats to the crops in India and the US, plus a USDA forecast that points to tighter ROW ending stocks this season, although the market is questioning the validity of the government’s numbers.
On the bearish side we have sluggish consumption around the globe and it is still anybody’s guess at what level mill use really is. Then there is the threat of further turmoil in the emerging markets, which has the potential to escalate into a global credit crisis.
Over the next couple of months we should get some clarity on where we stand in regards to the cotton balance sheet, but until we do, the market is likely to remain rangebound.
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