NY futures came under pressure this week, as May dropped 367 points to close at 84.66 cents, while December fell 228 points to close at 85.66 cents.
The breach of technical support triggered some profit taking by speculators earlier in the week, sending the spot month to a low of 84.38 cents on Tuesday, which was nearly 10 cents below the March 15 high. However, the USDA supply/demand and US export sales reports helped to stabilize prices over the last couple of sessions, as they reminded traders why the market has been so strong over the last six months.
YesterdayΆs USDA supply/demand report continued to broadcast a familiar message – rising stocks in China (+ 1.5 million bales) and falling stocks in the rest of the world (- 0.79 million bales). Six months ago, when the market started to move higher, with May trading at just above 71 cents on November 9, the USDA that same day estimated Chinese ending stocks at 37.11 million bales and ROW stocks at 43.16 million bales. Since then, we have seen quite a dramatic shift in these two stock numbers, with the Chinese inventory growing to 45.61 million bales (+8.5 million) and ROW stocks dropping to just 36.84 million bales (- 6.32 million).
This transfer of relatively inexpensive ROW stocks to China, where domestic prices remain about 50 cents above the A-index, is the main reason why spot futures are still trading 12 cents higher than in November, after having been up by as much as 20 cents a few weeks back. The trade numbers in the USDA report confirm this strong flow of cotton into China, as global exports have risen by 5.47 million bales since November, from 36.45 to 41.92 million bales, with China singlehandedly accounting for the entire increase.
However, the rise in cotton imports is only part of the story, since China has also been absorbing vast amounts of cotton yarn from the rest of the world. At the current pace, China may import the equivalent of 7 to 8 million bales of cotton in the form of yarn, which would be more than twice as much as a year ago. So not only do we have fewer cotton stocks available in the rest of the world, but we are also seeing stronger mill use in several markets due to this extra demand for yarn.
As long as this absurd transfer of cotton and yarn to China is allowed to continue, prices in the rest of the world are not likely to fall by much. This week the Chinese government announced that it would continue its support program for a third season, by buying an open-ended amount of cotton between September 2013 and March 2014 at the existing rate of 20Ά400 yuan/ton, which converts to around 148 cents/lb at todayΆs exchange rate. Over the last 3 seasons, Chinese stocks have grown from 10.6 million bales to 45.6 million bales, an increase of 35 million bales! To put this into perspective, China has stashed away the equivalent of two US crops in just three years and there is still no end in sight to all this stockpiling.
TodayΆs US export sales report showed continued strong demand for US cotton, as a total of 19 markets bought 152Ά700 running bales of Upland and Pima cotton for the current marketing year, plus 17Ά300 running bales for shipment August onwards. Total commitments for the current season now amount to nearly 12.2 million statistical bales, of which 8.7 million bales have already been exported.
Despite the “Goldman roll”, a five-day period during which index funds roll their long positions forward, we have not seen much of a reduction in open interest. Combined bets in May and July still amounted to 157Ά314 contracts or 15.7 million bales as of this morning, down just 9Ά110 lots from a week ago. With the Goldman roll ending today, liquidity will probably dry up over the coming sessions, which could lead to a more volatile market given the large open interest.
So where do we go from here? The bulls pin their hopes on tight stocks outside China, potentially strong mill demand in the second and third quarter, and a large trade net short position in the futures market that needs to be covered. The bearish camp focuses on record global ending stocks, a deteriorating technical picture and the fact that hedge funds have been abandoning commodity positions recently, although we have yet to see a significant drop in cotton open interest. The chart doesnΆt look too good at this point and the next major support area is still over 3 cents away at just above 81 cents, where there is an uptrend line dating back to early November as well as a cluster of lows made in February.
The market is probably not quite done to the downside and may have to regroup in the low 80s before launching another rally attempt. However, given the large trade net short in futures and the small amount of unsold US cotton, we may not have seen the last of this bull market yet!
Best Regards
