NY futures went on a roller-coaster ride this week, but in the end December still managed to gain 371 points to close at 144.21 cents, while March advanced 252 points to close at 139.18 cents.
Wednesday’s key-reversal session may be remembered for many years to come, because after posting a new historic high of 157.23 cents in December, the market tanked by 1200 points and closed at or near limit-down, with total volume amounting to a record 101’516 contracts.
From a technical point of view a powerful key-reversal like this - especially when confirmed by a lower close the following day - typically signals the end of a prevailing trend. However, while we certainly need to pay close attention to what the chart is telling us, we do so with the awareness that China has it in its power to overrule any such technical considerations. We had a similar key-reversal on October 15, which proved to be nothing more than a blip since the cash market remained unimpressed and forced the futures market to resume its uptrend.
Chances are that we might be in a similar situation, since cash prices have yet to show signs of backing off significantly. In fact the A-index was still at 168.40 cents this morning, or about 24 cents above December and some 29 cents above March. Therefore, when measured against a historical spread of around 5-8 cents, the futures market would not necessarily have to go any lower from current levels even if cash prices were to drop by 20 cents.
On the other hand, should the cash market more or less hold, then the case can easily be made that NY futures are attractive by comparison, which may bring in takers as we head into the upcoming delivery period of the December contract. As we have stated before, in a tight season like this the board will be viewed as a potential source for physical cotton, especially since all but 1’011 bales of the certified stock (around 45’000 bales including those under review) consist of current crop. Therefore, the lower the market goes over the next few sessions, the more attractive the certified stock will look.
This week’s USDA supply/demand report finally addressed the tight supply situation in China, as beginning stocks were lowered by 3.0 million bales to 15.24 million bales, or around 3.5 months of mill use. For the current season China’s crop was taken down to 30.0 million bales and mill use was reduced to just 47 million bales, due to potential demand destruction. Despite this sharp drop in demand, the seasonal production gap in China remains very high at 17.0 million bales, and unlike last season there are basically no more government reserves available to help bridge this gap, which means that nearly the entire shortfall has to be covered by imports.
The USDA increased Chinese imports by 2.0 million bales to 15.0 million bales, but where is China going to get all these bales from? As we have mentioned last week, China has so far bought just 3.7 million bales from US shippers and the amount of unsold cotton in the US is dwindling fast.
Let’s take a quick look at the US balance sheet! The US crop has just been lowered to 18.4 million bales, which combined with 2.9 million bales in beginning stocks gives us total supply of 21.3 million bales. From that we need to take off 4.5 million bales for domestic mill use (3.5 million for the current season and 1.0 million for Aug/Oct 2011) and 12.7 million statistical bales in export commitments as of October 28 (11.8 million for the current season and 0.9 million for next marketing year). This leaves only around 4.1 million bales available for sale - not counting what has been committed over the last two weeks!
We believe that it is supportive for prices that China has so far booked just 3.7 million bales from the US, because it means that even if China were to take the entire unsold balance, it would get to no more than 7.8 million bales for the season. But since China probably won’t be able to secure more than 2.5 out of these remaining 4.1 million bales in the US, it will have to become all the more aggressive in other growths, be it India, Africa, Central Asia, Brazil and Australia. We estimate that China will have to buy a minimum of 9-10 million bales from these origins to make it through the season.
So where do we go from here? In the short term we expect to see further weakness in the futures market since this key-reversal will invite selling from the spec sector, be it profit taking or new short selling. The slightly stronger dollar and interest rate hike in China may add to the downside momentum. However, in the longer run we need to follow the physical market because it continues to hold the key to prices. It will be interesting to see how mills react to this sell-off, because the typical reaction is for mills to back off when prices are falling, but since the US is already about 80% committed this early in the season and China still has substantial amounts to cover, we don’t expect buyers to be as patient as usual. All this sell-off may therefore do is accelerate the selling of any remaining supplies, which would prove to be very bullish down the road.
Best Regards
