NY futures continued to slip this week, with December giving up another 119 points to close at 63.55 cents.
The cotton market continued to display a weak appearance, as December closed today at the lowest level since April 20. From a technical point of view December has now breached an uptrend line dating back to late January and is gaining distance to its long-term moving averages, which are still bunched together near the 65 cents level.
So far spec long liquidation has been surprisingly light, with hedge funds seemingly giving the cotton market a lot of rope, but at 63.50 the market has now entered the ‘red zone’ where sell stops are likely to intensify. The latest CFTC report of July 21st showed speculators still at 4.9 million bales net long, which was only down 0.6 million bales from the recent peak. Since open interest in the futures market has hardly moved in the seven sessions since that report, we have to assume that speculators have so far remained patient with their positions.
We believe that there are several reasons behind the cotton market’s renewed weakness. For one, crops are generally in good shape, while mill demand remains subdued, which makes it doubtful that the world will be able to lower its burdensome stocks next season. From a broader perspective we have the ongoing rout in the commodity sector, where prices have fallen to levels not seen since the early 2000s, as well as some worrisome developments in emerging markets.
This week the JPMorgan Emerging Market Currency index dropped its lowest level since it was created in 1999, with currencies like the Malaysian ringgit and Indonesian rupiah testing levels last seen during the Asian crisis. On the other side of the globe, Brazil has seen its currency fall by over 20% so far this year and this slide could continue as there is a risk that the country’s debt might be downgraded to junk status next year.
With financial assets (stocks, bonds) and currencies falling at the same time, the capital flight that started in the second half of last year is accelerating, leaving many of these emerging markets in dire straits. According to McKinsey, total emerging market debt reached US$ 49 trillion at the end of 2013, accounting for nearly half of the global debt growth since 2007.
The risk is that many of these emerging markets may find it difficult to finance their increasing current account deficits, and foreign exchange reserves are not large enough to stop the bleeding. This in turn could lead to defaults and spread this emerging market crisis into a global one, since many of the creditors consist of international banks and hedge funds.
These developments are not helping cotton prices, since it becomes more expensive for emerging markets to buy and finance dollar-denominated imports. For mills that produce yarn and finished products for export this may be less of a issue, but for countries like Indonesia or Turkey, which have large domestic markets, it is starting to weigh on mill use.
US export sales for the week that ended on July 23rd came in more or less as expected at 99’200 running bales for Upland and Pima combined, while shipments maintained a decent pace with 183’200 running bales crossing the border. With eight days to go in the marketing year, total commitments now amount to 11.8 million statistical bales, of which 11.0 million bales have so far been exported. Sales for the 2015/16-season are so far at 1.95 million statistical bales, to which we will have to add an estimated 0.6 million bales carryover. In other words, we will begin the new marketing year with around 2.6 million bales on the books.
China has clearly slowed down its buying of US cotton, as there are currently only 79’900 running bales in outstanding sales on the books for the current marketing year, plus an additional 17’400 bales for next season, for a total of just 97’300 running bales. By comparison, a year ago combined outstanding sales still amounted to 675’600 running bales. It is quite clear that China doesn’t have the same appetite for imports anymore and realistically the US shouldn’t count on more than 1.3-1.5 million bales in Chinese imports, or about half of the 2.6 million bales it shipped this season.
So where do we go from here? Both from a technical and a fundamental point of view the odds seem to favor lower prices at this point. Spec longs are under water and given the deteriorating technical picture, we expect them to start liquidating unless the market finds some unexpected strength in the sessions ahead.
A washout of spec longs would likely lead to a breach of long-term technical support at 63.00 and 61.50 and cause the market to temporarily overshoot to the downside. However, we believe that values would bounce back as the selling is likely to be limited to long liquidation, since growers are not going to hand over their cotton in the low 60s. Considering that the cotton pipeline in the US is basically empty and that there is government support in the US (loan) and India (MSP), we don’t expect any sustained pressure to develop before new crop is harvested.