NY futures pulled back this week, as July gave up 189 points to close at 86.03 cents, while December dropped 168 points to close at 85.33 cents.
The market has been in a state of confusion ever since the latest USDA supply/demand estimate was released last Friday, as traders seem to have difficulty making sense of the data. The main message we take from the USDA report, which includes a first look at the 2013/14-season, is that the divergence between China and the rest of the world (ROW) is going to become even more pronounced as we head into the coming season.
According to the USDA, stocks in the ROW will be at just 36.52 million bales at the end of 2012/13, down from 40.14 last season, and are expected to fall even further to just 34.15 million bales by the end of 2013/14. That would be the second lowest stock level in eleven seasons! Only the 2009/10-season saw smaller inventories outside China at 32.41 million bales.
While ROW stocks are getting tight, Chinese stocks are reaching ridiculous proportions with an estimated 48.26 million bales at the end of this season and 58.18 million bales at the end of 2013/14. ThatΆs an inventory the size of more than three US crops!
As long as China continues to import and stockpile vast amounts of cotton, prices in the ROW should remain well supported and may actually trend even higher. According to USDA, China imported 24.53 million last season and is expected to take in 18.25 million this season and 12.00 million in 2013/14. That amounts to a mindboggling 54.78 million bales in just 3 seasons!
The USDA estimate of 18.25 million bales for the current season may actually prove to be conservative, because in the first nine months of the marketing year China has already imported 15.95 million bales (August 2012 to April 2013) and the final tally for the season may therefore be closer to 20 million bales. To put that into some perspective, over the last 21 months Chinese imports have totaled 40.5 million statistical bales, averaging over 64Ά000 bales per day!
US export sales of a combined 151Ά700 running bales for both marketing years were quite decent considering that only around 2.1 million bales of current crop remain available. The fact that 18 markets participated in the buying tells us that there is still widespread demand for US cotton. Weekly shipments were once again excellent at 330Ά400 running bales, leaving just 2.46 million bales outstanding, which at the current pace would be shipped in just over seven weeks.
Plantings in the Mid-South and Southeast made rapid progress this week, as warmer and drier weather finally allowed farmers to move into their fields. We guess that about 60% will be in the ground by the end of this week, while the balance should get planted next week. Texas on the other hand remains an area of great concern, since there is still no rain in the forecast and temperatures are expected to climb to 100 degrees by tomorrow. In other words, Texas finds itself once again in a race against time, and with every week that goes by traders will get a little more nervous.
So where do we go from here? We are definitely in one of the more difficult market environments in recent history! Instinctively traders are inclined to go short, considering that global stocks are climbing to unprecedented levels. In 2010/11 we had worldwide inventories at 49.4 million bales and by the end of next season they are predicted to be nearly twice as large at 92.7 million bales. However, the reality is that we have a split market, with China drowning in cotton, yet importing more with reckless abandon, while the rest of the world is looking at the second lowest ending stocks in a decade. Sooner or later there will come a time when China will no longer allow its stock levels to rise by ten million bales a year, but some sources believe that we wonΆt see a major policy shift until early next year.
While in a free market environment prices would probably collapse to 50 cents, the current set-up may actually force values to rise to a dollar, especially if the Northern Hemisphere were to encounter some crop problems. With the long-term outlook so unpredictable, traders will likely become less inclined to hold large forward positions and will instead focus more on nearby business. The futures market seems to already reflect that, since we have an unusually low open interest in December (58Ά518 contracts) compared to July (122Ά502 contracts). The last time we had such a low ratio was in 2009, after the financial crisis led to a lack of visibility.
The fact that we have so many outstanding bets on July could lead to some volatile swings in the weeks ahead. The index fund roll will provide much needed liquidity for July shorts to get out or roll forward, but beyond that a lot will depend on what the spec longs decide to do. Some traders hope for technical weakness to flush out the spec longs, similar to what happened two month ago when specs liquidated over 4 million bales in matter of weeks. However, if support holds and Texas doesnΆt get rain soon, it may this time around be the shorts that blink first. In view of this huge open interest in July we expect to see a rather erratic and volatile market over the next four to five weeks. Given the low stock levels in the ROW and the current Texas weather, the risk seems to be greater to the upside. The same goes for the longer-term outlook! As long as China continues to take away vast amounts of cotton from the ROW, we are likely to see firmer prices ahead.