NY futures continued their rally this week, with December gaining 349 points to close at 83.55 cents, while March advanced 377 points to close at 81.77 cents.
A bullish USDA report and strong US export sales provided additional fuel to an already buoyant market this morning. With the fundamental and technical pictures both aligned in the same direction, there seems to be very little in the way of this uptrend at the moment.
December has now gained 1054 points on a closing basis over the past 17 sessions. A look at the candlestick chart tells us that the bulls are firmly in control, since there were only 3 out of the last 17 sessions in which December closed below its opening. Open interest has risen from 157’763 contracts on July 20 to 193’543, which together with strong volume on up days (over 30’000 lots today) validates the bullish case. Furthermore, October has now closed well above the continuation high of 84.94 cents, confirming a breakout on the weekly chart, while December eclipsed last week’s high and closed at a 22-month high.
The USDA report finally confirmed what the market had already been suspecting for a while, namely that inventories had to be much tighter than what statistics were telling us. World stocks as of August 1st were lowered by 3.41 million bales to 47.58 million bales, with the biggest reductions occurring in China (-1.21), India (-1.15), Pakistan (-0.61) and Brazil (-0.37). While the reduction in China was a step in the right direction, we feel that 19.3 million bales (4.2 million tons) are still overstating actual stocks by some 3-4 million bales.
Somewhat surprisingly the USDA increased US beginning stocks by 0.2 million bales to 3.1 million bales, which was due to a change in exports for 2009/10. The USDA lowered last season’s exports from 12.25 to 12.0 million bales, even though its final report for the 2009/10 season shows that 11.826 million running bales of Upland and Pima were shipped, which according to our calculation (using 496 lbs for running bales) translates into 12.22 million statistical bales.
World production was increased by 830’000 bales to 116.85 million bales, with the biggest changes coming from India (+1.0), Pakistan (-0.7), the US (+0.23) and Turkey (+0.2). Even though global production is 14.7 million bales higher than last season, it is still not enough to catch up to projected mill use of 120.87 million bales. This marks the fifth season in a row in which global output is predicted to fall short of consumption. What’s striking is how big the foreign production gap has become, with last season’s record 24.35 million bales shortfall followed by yet another huge deficit of 19.15 million bales this season.
This places an ever-increasing burden on the US to fill these gaps, since drawing down inventories is no longer an option after we have arrived at the lowest stocks-to-use ratio since 1994/95. Stocks are expected to be at just 45.6 million bales at the end of this season, which would amount to about 4 ½ months of mill use. However, we need to consider that the statistical season and the actual cotton season are not synchronized, since the statistical year begins on August 1, while the bulk of the Northern Hemisphere crops, which produce about 90 percent of total output, does not arrive in volume until October/November. With mills around the globe consuming about 10 million bales a month, they draw down stocks during August, September and October before new supplies begin to move in. Therefore, if the statistical year were to begin on November 1 instead of August 1, beginning stocks would probably be down to just 25 million bales, which is extremely tight since there are other factors such as logistics and quality to consider. In other words, the global supply pipeline is about as tight as it can get without causing any panic.
Today’s export sales report showed that for the week of August 5 an additional 346’200 running bales were committed for the current marketing year, while 20’500 running bales were added for 2011/12. This brings total commitments, including the 1.8 million bales that were carried over from last season, to 5.9 million statistical bales, which is the highest amount at this point in the season in 16 years. The USDA estimates US exports for the current marketing year to reach 15.0 million bales, up 700’000 bales from last month, but even if the US were to ship that many bales it would still not be enough to close the foreign production gap.
So where do we go from here? The market is firmly in the grip of the bulls at the moment and we don’t believe that this is going to change for at least another 3 months. The tightness is for real, stocks cannot be drawn down any further and available exports will not be enough this season to satisfy the current level of demand. The market will therefore have to ration demand via rising prices. How high prices will need to climb to achieve this goal remains to be seen, but we don’t seem to be quite there yet. Last week we thought that 85 cents would be a good upside target, but after this week’s performance we cannot rule out spikes to 90 cents anymore. The downside appears to be very limited as there are plenty of traders who would like to buy the market on dips, among them the more than 8.0 million bales in unfixed on-call sales.
Best Regards
