NY futures traded slightly lower since our last report on December 23, with March giving back 101 points to close at 72.89 cents.
Although the futures market started the new calendar year on a strong note by rallying to an intra-day high of 76.77 on Monday, it proved to be nothing more than a flash in the pan as values have since dropped by nearly 400 points. This correction seems to be the result of spec selling and index fund rebalancing, against which the trade has been a decent scale down buyer.
As expected we have seen the spread between the A-index and spot futures move back towards a more traditional difference recently. This morning the A-index measured 78.45 cents, while March closed at 72.89 cents, resulting in a spread of 556 points. Just a couple of months ago we had spot futures trading above the A-index, which is rather unusual and usually short-lived. Also, as of this morning we have once again a US quote (MOT at 79.25 cents) in the index after a five-month absence, which in our opinion is supportive because it signals that US cotton is competitive on the export front.
US exports were already quite strong before this week’s price drop, as sales over the two-week holiday period amounted to no less than 583’200 running bales of Upland and Pima. Total commitments for the season now stand at 6.5 million statistical bales, whereof 3.6 million have so far been exported. Some analysts were disappointed about last week’s export sales of 208’500 running bales, but we need to remember that if the US were to sell that amount every week, we would run out of cotton by the end of September.
We believe that the market does not yet fully appreciate how tight the US statistical situation is this season. We started last August with beginning stocks of around 6.3 million bales, to which we add the latest crop estimate of 12.6 million bales to arrive at total supply of 18.9 million bales. From that we need to subtract the 3.4 million that US domestic mill will have taken up by the end of July, which leaves 15.5 million bales available for export. Taking away the 6.5 million bales that have already been committed overseas leaves us with around 9 million bales that are still for sale. That may sound like a lot of cotton, but it really isn’t! If we were to sell just 200’000 bales a week, it would take 45 weeks to completely sell out of everything and at 250’000 bales a week we would reach the end of the line in just 36 weeks, or by the first week of September.
Knowing that mills around the globe continue to be short-covered and that Chinese mills are now armed with import quotas of 8.7 million bales, we believe that US supplies will continue to dwindle rather quickly over the coming months. If we are correct with our assumption, it could have some interesting implications for the futures market. While merchants may see to it that carrying charges get rebuilt between March, May and July, current crop futures may eventually detach themselves from new crop since there will be very little cotton left for sale at the end of this season. We therefore would not be surprised to see a considerable inversion develop between July and December.
The latest on-call report tells us that mills continue to hold out for lower prices. On January 1st there were 5.32 million bales of unfixed sales, up by over 100’000 bales net from the week before. So far the strategy to buy on-call has backfired on mills, as they have more than doubled their unfixed position from 2.6 million bales in early March, only to see the market rise from 40 to 73 cents since then. By increasing this on-call position to such a sizeable quantity they have created a tremendous amount of support under the market and are thereby defeating their own purpose.
So where do we go from here? From a technical point of view the market has sustained some short-term damage, with March closing today at its lowest level since November 18. However, looking at the daily chart we are still holding above the uptrend line dating back to August 27, which currently runs through around 72.50 cents. Likewise on the weekly chart, where the market could retreat all the way down to around 67.00 cents without breaking the uptrend line dating back to early March. While short-term momentum is negative and a further setback cannot be ruled out, we don’t believe that this bull market is over yet. It may simply take a break and as we have pointed out before, we may need to see a change in the leadership from the speculative sector to the trade before the market is able to resume its uptrend. This is likely to happen as mills will use this break to fix some of their on-call sales and to buy additional supplies, which in turn will prompt merchants to buy short futures back. This should provide enough support to stabilize prices and to eventually turn the market around.
We believe that China will play a major role in the world market over the coming months, as domestic prices have remained at elevated levels in very active trading. The CC Index stands at over 99.00 cents, while at the Zhengzhou futures market prices are as trading between 104.00 and 113.00 cents. Today the September contract, which was the most actively traded, closed at 112.88 cents. It is therefore more than likely that Chinese mills will be ready to take advantage of any break that presents itself in the world market.
Summing up, we may see a period of consolidation between 70.00 and 75.00 cents in the near term, but we believe that old crop will eventually resume its uptrend and we expect prices to reach above 80.00 cents by the second or third quarter.
Best Regards
