To make up the supply gap of cotton in the future, China is very likely to increase the import quotas. However, there is almost no supply gap in 2018/19 season, and on concern about the additional allocation of import quotas and lower consumption, Chinese cotton prices are expected to be weak, and the import yarn advantage will also be diminished. The additional allocation of import quotas are expected to increase the cotton yarns, but under the anticipation of depreciation of RMB and emerging currencies, imported cotton shall have high cost performance compared to Chinese cotton. Chinese and foreign cotton prices are likely to be pressed by each other.

1. China has no supply gap in 2018/19, inventory is high, and the consuming time is long

After the end of state cotton auction in Sep, remaining stocks of reserved cotton in state warehouses are projected at about 2.75 million tons. If the cotton auction continues in 2019 during Mar to Sep, then the reserved cotton stocks may be sold out totally. Though accumulated temperature in Xinjiang during Sep and Oct is low and hoarfrost comes earlier, the harvests in North Xinjiang are fast and the output is still expected to rise. In South Xinjiang, the hand-picked harvests are slow and machine-picked harvests only start in Oct, the final output may be affected, but it is within the range. Therefore, the output in 2018/19, plus the reserved cotton stocks, can meet the consumption well. There may be quality issue of reserved cotton, but the imported cotton can also be made up the gap. The additional 800kt of sliding-scale duty quotas have been released in Oct, and 2019 894kt of tariff-related quotas has started to apply, so supply is sufficient this season.

It is a big year for textile industry in 2017/18 season, and global cotton consumption has significant increase. However, from Sep, the new orders of textile mills were less compared to Jun-Aug, and no any active sentiment is seen in traditional buoyant season this year. The largest influencing factor is the Sino-U.S. trade war. The end-user market is impacted obviously. Besides, the finished products exports slow down affected by lower printing and dying capacities, leading to grey fabric inventory accumulating among weavers, printing/dyeing plants and traders. So the demand for the upstream market weakens.

By now, the relation between U.S. and China is still strained, and whether there will have additional tariffs on other products remains questioned, so the replenishment in the industrial chain is cautious overall. Cotton consumption is expected to reduce in 2018/19 season, while supply is sufficient, so commercial stocks are high, needing time to digest. Chinese cotton prices are expected to be weak if there is no big bullish news.

2. The additional allocation of cotton quotas in China is likely to increase the consumption for international cotton, but the right to use is in China, and with the exchange rate risks, the domestic cotton market will influence the foreign cotton market later
On Oct 10, additional 800kt of sliding-scale duty quotas has been allocated to mills, but the calculation method has not been updated (using the standard in 2015). Besides, the 2019 894kt of tariff-related quotas has started to be applied. Moreover, it is expected that there will be additional sliding-scale duty quotas in 2019.

To allocate additional quotas is to give possibility to increase the imported cotton consumption. Vied from recent years, imported cotton prices are lower than domestic cotton, even the Australian cotton, the prices are lower than Xinjiang cotton. So the quotas under 1% tariff can be used up every year. Therefore, it is good news for international cotton market if China increases the quotas.

However, if the quotas are released more, the supply will increase, to seize the shares of domestic cotton. With no supply gap, Chinese cotton prices may weaken and price spread between Chinese and international cotton is bound to narrow.

To use the cotton quotas depends on the cost performance of imported cotton compared to domestic cotton. Once foreign cotton prices are higher than domestic cotton, quotas will be hard to be used. If Chinese cotton prices weaken, international cotton prices shall be lower and then cotton quotas can be used. Meanwhile, the use of quotas is also affected by the exchange rate, and the high tariffs of U.S. cotton increase the difficulties of choosing the alternative sources. For late market, ZCE cotton futures market may affect ICE cotton futures.

3. Imported yarn advantage weakens, and the depreciation of emerging currencies leads to lower demand from Southeast Asia
In 2018/19 season, China still has reserved cotton, and with the cotton quotas, imported yarn market shares are estimated to be squeezed, and Chinese cotton consumption is expected to reduce. China is the largest importer of cotton yarn, and India, Vietnam and Pakistan are the major yarn exporter. With the lower market shares in China, the cotton consumption in Southeast Asia may lower. Moreover, Southeast Asia is the world major cotton importers, the lower consumption will influence the overall international market. In long term, yarn exports meet resistance, likely to stimulate domestic sales or export of grey fabric or downstream products.

U.S. cotton is the major product in international cotton market. The Sino-China trade war restricts the imports of U.S. cotton to China, and the demand seeks for the alternative sources. Nevertheless, the Southeast Asia is also affected by China’s policy and consumption. Meanwhile, U.S. has the anticipation to raise the interest rates, and the depreciation of emerging currencies is not good to the cotton consumption, especially those countries with less foreign exchange reserves, which may triggers “hyperinflation”.

4. U.S. loses the orders from China, and the gap cannot fulfil from other countries
Barring the medium to long problems above in global market, U.S. cotton export sales also show bearish in short run. By end Jul, 2018, China has purchased 410kt of 2018/19 U.S. upland cotton, but by Oct 11, the purchasing volumes decline to 378kt, and the purchasing volumes of 2019/20 U.S. upland cotton rise to 185.5kt.

Especially entering Sep, China cancels large orders of 2018/19 U.S. cotton, turning to purchase 2019/20 U.S. cotton. After our survey, Chinese mills have discussed with China to move the 2018/19 orders to 2019/20 season. If the trade relation eases, U.S. cotton will be imported. But if the trade relation fails to improve, will orders continue? Nevertheless, it is obviously that China is decreasing the 2018/19 U.S. cotton consumption.

After China decreases orders of U.S. cotton, does U.S. cotton turn to other destinations? According to the monthly export sales, since 2018/19 season, export sales to other countries are also decreasing. It is to say that the consumption from other countries has not increased, but keep decreasing.

Therefore, ending stocks are projected up, weighing on ICE cotton futures and other international cotton market based on the basis trading by ICE cotton futures.