NY futures added to their gains this week, as July advanced 139 points to close at 92.11 cents, while December improved by 76 points to close at 89.07 cents.

After three consecutive weeks of negative net US exports sales, fears of additional cancellations were eased this morning after the latest report revealed an increase in net sales of 149Ά100 running bales of Upland and Pima for the current marketing year and 56Ά000 running bales for 2012/13. It was encouraging to have China back as a net buyer, with a total of 113Ά800 running bales between the two crop years. As in weeks past, the buying continued to be broad-based, as no less than 14 markets were buying US Upland last week. Total commitments are now back at 12.0 million statistical bales for the current marketing year, whereof a little less than 8.1 million statistical bales have so far been shipped.

TodayΆs US export sales report was of psychological importance to the market. Not only did it put a stop to the recent string of cancellations, but it also showed that China is still a keen buyer if the price is right. What remains a mystery is how much quota is still unused. By some estimates it amounts to less than 200Ά000 tons, although there were rumors this week that the Chinese government may issue a supplemental quota of 1.0 million tons some time in May, probably after growers have made their planting decisions. This additional quota may be tied to the release of Reserve Stocks, whereas one unit of imported cotton would have to be matched by buying one unit of Reserve cotton.

Imports are still very attractive in China at current international prices when compared to domestic cotton. In fact, local traders have been paying over RMB 3Ά000/ton (over 20 cents/lb) to acquire import quotas and are apparently still able to make a decent profit on it. Even though the Reserve has recently suspended its auction purchases until new crop, it has siphoned off over 3.13 million tons (14.4 million bales) of domestic cotton this season, which has led to an artificially tight local market and kept prices well supported. The China Cotton Index has been hovering just north and south of 140 cents since last July!

Although Chinese imports are expected to rise to a record 20.5 million bales this season, they still amount to only about half of Chinese mill use, which is currently pegged at 42.5 million bales. Therefore, as long as this huge price gap between China and the rest of the world exists and as long as there are quotas available, imports will continue unabated. We believe that the many shorts in July are playing a dangerous game, because they are to a large degree depending on what the Chinese government decides to do next. If China continues to sit on its reserves for the foreseeable future and instead allows additional imports to supply the local market, then a short squeeze becomes a possibility.

China has not only been an active importer of cotton, but since foreign yarn is made from much cheaper cotton as well and spinning is not a labor-intensive process, there has been quite an increase in cotton yarn imports recently. In the first quarter, cotton yarn imports rose by nearly 50% to 264Ά004 tons, with Pakistan and India supplying more than two-thirds of the total. On a net basis (yarn imports minus yarn exports), China took in 179Ά318 tons in the first quarter, which compares to just 77Ά531 tons a year earlier.

The latest CFTC report as of April 17, which includes futures and options, revealed that large and small speculators had basically a flat position at just 0.1 million bales net long although they still carry relatively large outright positions at 6.1 million bales long and 6.0 million bales short. Index funds had a net long position of 7.5 million bales, while the trade was on the other side with a 7.7 million bales net short (5.7 million long and 13.4 million short). We are a bit concerned about this large trade short position, especially the 13.4 million bales in outright shorts. Although some of these shorts belong to new crop, the majority of them are in July. Since the US has only about 2 million bales for sale this season, these shorts are mainly against long positions in origins like Australia, Brazil, or the many consignments that clutter Chinese ports at the moment. Additionally there are still about 2 million bales in unfixed on-call sales, against which shippers may have sold futures to lock in the price.

Since China still seems to be active on the import front, especially if an additional quota were to be released, and since mills all over the globe are not well covered, a lot of these basis-long positions should find a home over the next couple of months, which would mean that short hedges get bought back. This net buying in July could trigger some technical buying, which would prompt specs to jump into action, both in terms of new buying as well as short-covering. Since Index funds, who hold the biggest block of longs, will not be active for another 5 or 6 weeks, the set-up for a short-covering rally in July seems to be in place.

So where do we go from here? Although the long-term sideways trend is still very much in force and we donΆt expect that to change anytime soon, it looks like July is ready to generate some short-term momentum to the upside which could propel values into the high-90Άs. With China once again lurking on the import front, shorts need to be on alert and should be ready to get out of harmΆs way if July were to close above the 94.00 cents resistance area. December is still a different story! Although it may get dragged along by a July rally, the fundamentals going forward are still bearish and we would use strength to sell into December, preferably with the use of options, which are relatively cheap at current volatility near 20%.

Best Regards