NY futures closed basically unchanged this week, with March inching up just 2 points to close at 72.91 cents.
The market made a valid attempt to generate new upside momentum on Monday by rallying all the way up to 74.49 cents, but there was simply no follow-through buying and values quickly retreated to their recent lows. To make matters worse for the bulls, today’s close was slightly below the uptrend line dating back to August 27 on the daily chart, which may invite additional spec selling in the sessions ahead.
The latest USDA supply/demand report and today’s export sales report were reminders that perception is often more powerful than reality. In both cases the expectations for more bullish numbers were not met and the market ended the respective sessions with sharp losses. However, in our opinion both of these reports were anything but bearish and should instead be seen as building blocks for a strong bullish case going forward.
The USDA report showed only minor changes overall, with world production basically being left unchanged at 102.71 million bales and world use down a minor 150’000 bales at 114.36 million. Of course the devil lies in the details and there was a 500’000 bales increase in the Chinese crop to 32.0 million bales that caught some traders by surprise. However, while China, who is the world’s largest importer, saw its crop estimate raised, the US and India, who are the world’s two leading exporters, had their production numbers reduced by 200’000 and 300’000 bales, respectively. Since China seems to have no intention to slow its imports, the fact that the US and India have less to offer to the world should in our opinion be seen as bullish, not bearish.
Today’s US export sales number also failed to live up to expectations after the ‘whisper number’ had sales at 500’000 bales or more. However, a marketing-year high of 440’700 running bales of Upland and Pima is certainly nothing to sneeze at. For the current season total commitments have now reached just under 7.0 million statistical bales, with almost 30 more weeks to go until the end of July. After adjusting for the lower US crop estimate and taking last week’s export sales into account, the US had only about 8.35 million bales left for sale as of January 7th. We can’t stress enough how little cotton that is given that mills have hardly any forward coverage and with China having a voracious appetite for imports. It is still a very long 9 or 10 months until new crop will bring relief.
The latest on-call report shows that mills took advantage of last week’s dip to fix a substantial amount of cotton. As of January 8, unfixed on-call sales dropped to 4.95 million bales after a net reduction of 332’400 bales during the week. Unfixed on-call sales in current crop March, May and July still amount to 3.54 million bales, which will provide decent support as this amount needs to be fixed within the next five months.
The CFTC spec/hedge report confirms that it was spec selling into trade buying that brought the market under pressure since the New Year. As of January 5, which includes last Tuesday’s big selloff down to current levels, speculators had reduced their net long in futures and options to 5.65 million bales, which is down about 0.8 million bales from the week before. The trade was on the other side, reducing its net short position by 0.8 million bales to 13.65 million bales. Surprisingly, index funds maintained their position at 8.0 million bales net long despite rumors of significant rebalancing, although it is possible that some of that took place this week only.
So where do we go from here? The market seems to have found a level at which mills are happy to buy and fix sizeable quantities. Even though the bulls may be disappointed with the market’s recent performance, the fact that the current price break allows a lot of business to take place is supportive in the longer run. The faster we sell out of cotton, the sooner the record foreign production gap will be exposed. Outside the US, the projected stocks-to-use ratio will be the lowest since the 1994/95 season and we all remember what happened with the market in 1995. For those who need to refresh their memory, cotton prices topped out at 117.20 cents in April 1995 and there was an inversion between current and new crop of well over 30 cents. We are not suggesting that we will see a repeat of what happened 16 years ago, but we do have similar dynamics in place today, with old crop supplies getting tighter and tighter as we head into the second and third quarter, while increased new crop plantings hold the promise of a more ample supply situation in the coming season. This could very well lead to a pronounced inversion of the May/Dec and July/Dec spreads and we therefore see this as a relatively low risk play to take advantage of a potential supply squeeze as we head towards the end of the current season.
As far as outright prices go, we see the potential for a further setback in the short term as speculators may sell additional quantities in light of the dismal technical performance, but we would welcome any further setbacks as a buying opportunity. Barring any unforeseen events on the macroeconomic front, we believe that cotton prices are destined to move higher, potentially much higher, by the second or third quarter.
Best Regards