NY futures were able to extend their rally this week, but not by much, as March advanced just 95 points to close at 95.69 cents.

There were several crosscurrents that led to the market’s choppy trading action this week. On the buy side there was a strong bid related to the annual rebalancing of the S&P Goldman Sachs Commodity Index (S&P GSCI) and the Dow Jones–UBS Commodity Index (DJ–UBSCI), which began on Monday and will complete on Friday. This year cotton is one of the beneficiaries of this rebalancing process and according to some estimates it will lead to the net buying of about 12’000 – 15’000 contracts.

Due to the fact that this index fund rebalancing, which is based on strict rules with no discretion applied whatsoever, was publicized well in advance, it is believed that hedge funds and speculators have preempted the event by accumulating long positions. This is evidenced by the strong rise in speculative open interest in recent weeks and it may explain at least some of the market’s strong performance we have seen lately. As index funds were buying this week, speculators were apparently selling into it, taking profits on their recently acquired long holdings.

According to the latest CFTC spec/hedge report of January 3rd, the speculative net long position increased by a massive 16’860 contracts, or about 8% of open interest in Futures and Options. The trade has been a seller into this wave of spec buying, increasing its net short position by 13’971 contracts to a total net short of 6.35 million bales. Since the US crop is already well committed, most of these short futures are presumably against foreign crops.

The headline numbers of today’s USDA report put a bearish spin on the market, because even though global production was lowered by 0.58 million bales, global mill use was cut by an even greater 1.35 million bales, while ending stocks rose by 0.68 million bales to 58.35 million bales. However, when we examine the report in greater detail, it doesn’t look nearly as negative, because most of the changes occurred in China (consumption down 1.0 million bales, ending stocks up 1.5 million bales).

The statistics for the rest-of-the-world look a lot more encouraging, because not only did production (down 0.58 million) drop more than mill use (down 0.35 million), but due to the fact that China’s imports were raised by half a million bales to 16.0 million bales, ending stocks outside China actually dropped by 0.82 million bales, from 42.12 to 41.30 million bales.

While we agree with the USDA on its global production estimate, we struggle to see global mill use at less than 110 million bales. If it were, it would be the lowest consumption figure since 2004/05, when 109.1 million bales were used and it would also be lower than in 2008/09, when consumption dropped to 110.3 million bales in the wake of the financial crisis. Our objection is primarily based on logic, because there are now 500 million people more on the planet than in 2004/05 and many of the emerging economies like China, India or Brazil, just to name a few, have grown leaps and bounds since then. Also, yarn output, trade and retail sales statistics do not support a case for cotton consumption being at the same level as seven years ago. There is of course the man-made fiber argument, which has definitely eaten into cotton’s market share, but not to that degree when measured in absolute terms. While we don’t doubt that consumption may have temporarily dropped to a much lower level in the aftermath of last year’s chaos in the textile chain, we feel that mill use is now rebounding from these depressed levels.

In the case of China, the USDA stated in its comments that mill use was lowered because “the substantial accumulation in the national reserve is expected to support prices and constrain mill use”. But wouldn’t it follow that if China became less competitive, that mills in other parts of the world would pick up the slack? Yet the USDA has also reduced consumption in Thailand, Indonesia, Vietnam and Bangladesh by a combined 300’000 bales in today’s report.

Today’s US export sales report was quite constructive for two reasons. First, it showed a net increase in sales of 93’900 running bales, bringing total commitments for the season to around 10.7 million statistical bales, which is getting close to USDA’s revised estimate of 11.0 million for the season. This doesn’t include the 1.3 million bales that were sold under ‘optional origin’. Second, there were ‘only’ 18’500 bales cancelled last week, which is an improvement over recent weeks and raises hopes that the worst may be behind us. One thing we didn’t like in the report was the continuous slow pace of shipments, as only 169’300 running bales were shipped last week, although the holidays may have had something to do with that.

So where do we go from here? After rallying about 11 cents since the middle of December, fueled by speculative and index fund buying, will there be enough new buying to keep the upside momentum going? We doubt it, because the rebalancing will run its course this week, which takes an important source of buying out of the equation, and we don’t believe that either speculators or the trade will step in on the long side at this point. With the Chinese New Year just around the corner (January 23), mill buying will become a lot more subdued over the coming weeks. Also, the fact that corn and soybeans caved in today may cause negative vibes for cotton. We therefore believe that the market will enter a period of consolidation, during which values may retreat towards the low 90’s.

Best Regards