NY futures gave back some of their recent gains this week, as March dropped 258 points to close at 95.59 cents.

A rising trend requires constant new buying to keep its momentum going, but with Chinese buyers celebrating New Year, physical buying was less active this week and as a result we saw values come under pressure. Despite this week’s setback, the market has come a long way since posting a low of 84.35 cents on December 14. Since then, open interest has increased by nearly 20’000 contracts, rising from 146’435 to 166’183 lots.

Although there is little doubt that a sizeable portion of this new open interest is tied to the rebalancing of index funds, we nevertheless feel that speculators and hedge funds are viewing commodities in a brighter light these days. This has to do with the fact that leading economic indicators in the US and China are improving and that the European debt crisis seems to be contained after massive intervention by the Fed and ECB, ranging from swap lines to low interest long-term loans.

Earlier this week the Fed Chairman gave the financial markets a carte blanche on low interest rates until 2014 and at a press conference he even hinted at further quantitative easing. The Fed’s action signals to the market that there is still great fear of another financial crisis among policymakers and that they are willing to do just about anything to avert it. Gold reacted to the announcement with a big rally, advancing over 50 dollars/ounce in two sessions, and we have a feeling that the commodity complex will eventually follow the lead of precious metals.

Support in the cotton market is not only emanating from the speculative sector, but there has been a notable improvement in mill business in recent weeks. As we have stated repeatedly, the fact that Chinese prices are some 35-40 cents above the A-index has led to a revival of the yarn sector in many parts of the world. Under the Reserve’s price umbrella there has been keen import demand from China, not just for cotton, but also for yarn. While cotton is subject to import quotas, yarn is not, and we have recently learned of sizeable yarn business between various Asian markets and China.

This week’s US export sales report was labelled as disappointing, because current crop Upland sales of 68’500 running bales were offset by an equal amount of cancellations. However, current crop Pima sales increased by 49’500 running bales net and then there were also 34’500 running bales net of new crop Upland and Pima cotton. Commitments for the current marketing year now amount to 10.9 million statistical bales, of which 3.6 million have so far been exported.

We need to consider that the US has relatively little cotton left for sale and expectations for big export sales reports are therefore no longer warranted for the remainder of the season. When we look at the latest statistical position of the US, we have total supply at 18.3 million bales (2.6 beginning stocks and 15.7 crop), from which we have to subtract 10.9 million in export commitments and 3.6 million for domestic mill use. This leaves just 3.8 million bales available and we are only in January!

The Cotton Advisory Board (CAB) in India issued its latest forecast this week, estimating the current crop at 34.5 million local bales, which was right in line with the latest USDA estimate of 27.0 million bales, but higher than the consensus of most private forecasts. What came as a positive surprise was the domestic consumption number, which was raised by one million bales to 26.0 million local bales or 20.3 million statistical bales. This is 0.8 million statistical bales higher than the current USDA estimate of 19.5 million bales. We have long held the belief that global consumption is understated at 110.0 million bales and this may be the first evidence in that direction.

So where do we go from here? The market closed today right at an uptrend line dating back to the December 14 low and it will be interesting to see what happens next. If support is broken, the market will likely see some further downside action in the days ahead and if it holds it will probably attract new buying. The fact that March is finally starting to build some carry to May could be seen as a sign of weakness by speculators and may prompt some profit-taking. However, from a fundamental point of view we don’t see a lot of downside as long as Chinese prices remain as high as they are. The yarn market has definitely started to improve and we believe that there is a lot of buying waiting on dips. Therefore, our best guess is that the market will remain range bound in the foreseeable future.

Best Regards