NY futures came back with a vengeance this week, as July rallied 430 points to close at 82.51 cents, while December gained 267 points to close at 79.07 cents.
The market continued to free fall until Monday on additional spec selling, with July posting an intra-day low of 75.80 cents, but a slingshot-like rebound over the past four sessions took the spot month all the way up to a high of 83.99 cents this morning, before it settled at 82.51 cents.
The ICE Spec/Hedge report confirmed that it was heavy spec selling that brought the market to its knees last week, as specs liquidated 10’500 longs and added 7’242 shorts, which amounted to 17’542 contracts of net spec selling. The trade was in liquidation mode as well, as commercials got out of 4’021 longs and seized the opportunity to cover 21’763 shorts. Mills fixed nearly 900’000 bales of open on-call sales in July last week and as of last Friday there were just a little over 800’000 bales remaining.
Last week’s selloff set the stage for a bullish move this week, because it led to the cheapest prices around the globe and facilitated export sales of no less than 824’100 running bales, with 597’300 of them going to China. This marketing-year-high performance is simply amazing considering how little cotton remains unsold. Based on the low availability of cash cotton it is almost a foregone conclusion that a large portion of these sales will have to be supplied from the certified stock. Indeed we have seen a string of de-certifications over the past five days, amounting to over 280’000 bales, and there is almost certainly more to come.
When we look at the latest US statistics for the current season, we started with a total supply of 18.5 million bales, of which 13.1 are now committed for export and 3.5 will have gone to domestic mills by the end of July. In addition to that we assume that at least 0.8 million bales of the 1.75 million bales that are committed for August onward shipment will be supplied from current stocks and that domestic mills will need around 0.5 million from existing inventories for August/September consumption. This would leave just 0.6 million bales as of last week, but considering that additional export sales were made since last Friday, the US is now for all practical purposes sold out.
According to the Cotlook A-index (94.40N) it is not just the US that’s about to run out of cotton, since nearly every other origin is now quoted as nominal. The only eligible quote remaining outside MOT and Memphis is Uzbekistan at 98.25 cents. Not since the mid-90’s have we been in such a tight situation and new crop can’t come soon enough for mills in dire need of cotton.
Chinese prices continued to move sharply higher this week, as tight stocks and news about weather problems in Xinjiang and parts of the eastern growing areas were causing some panic among mills and traders. The CC index reached nearly 118 cents today, while the ZCE July futures contract traded at 122 cents and the CNCE June delivery surpassed 125 cents. Traditionally we are used to see a spread of around 25-28 cents between New York and Zhengzhou futures, but this week it traded between 40-44 cents and even higher against the CNCE, which leads us to believe that some smart traders may have figured out a way to arbitrage the two origins. For example, traders could import US cotton (certified stock) to free up some local stocks, which could then be used for delivery against the ZCE or CNCE.
The USDA supply/demand report of this morning confirmed what we already knew, namely that the stocks-to-use ratio is extremely tight and that it may even get tighter in the coming season. US stocks are expected to be at 2.9 million bales at the end of July and are projected to drop to 2.8 million bales in 2010/11, while inventories outside the US are estimated to drop from 49.3 million bales this season to 46.8 million bales in the coming marketing year. Despite all the worries in the financial markets about a double-dip recession, the USDA predicts global mill use to increase to 119.5 million bales, up 0.4 million bales from last month. The foreign production gap, which amounted to a record 22.3 million bales this season, is foreseen at 18.6 million bales in 2010/11, which would be the second highest ever. Even though the US crop may to turn out quite a bit bigger than the current US estimate of 16.7 million bales, every bale will be needed in order to fill this foreign production gap.
So where do we go from here? With current crop basically sold out and certified stocks moving to China, July has become a very dangerous, volatile contract to trade and the sky is the limit. Tomorrow the Goldman Sachs roll enters its final day and after that liquidity will drop to a trickle, leaving shorts vulnerable to a squeeze. We therefore advise any remaining July shorts to get out of harms way and for mills to fix their remaining on-call positions without further delay. Although next year’s global production is expected to be 11.4 million bales bigger, it is still going to fall 5.2 million bales short of consumption if we can believe the USDA forecast. Even if production ends up being higher than current predictions and consumption disappoints, it will probably not be enough to reverse the tight ending stock situation we are in. Pipeline stocks are going to be depleted by the end of summer and it will take several months to replenish them. We therefore see no significant price pressure building until late in the year, if at all. However, the December contract should encounter a lot of producer selling near 80 cents, which should keep it in check for now. We therefore expect December to trade in a relatively narrow range of between 76 and 82 cents until we have a better idea about how the new crop balance sheet is shaping up.
Best Regards
