NY futures closed mixed this week, with July dropping 171 points to close at 80.80 cents, while December moved up 35 points to close at 79.42 cents.
The market failed to show any excitement over yet another excellent export sales report this morning and prices remained under pressure throughout the session. Not only have we seen some technical deterioration over the past six sessions, with momentum stalling after the limit-up move last week, but it looks like cash prices are running into strong resistance as well.
Over the last two weeks the US has sold no less than 1.36 million running bales of Upland and Pima for both marketing years, with China alone accounting for 853’000 running bales. Most of these sales will be supplied from existing inventories and according to our calculation current crop cotton should now basically be sold out.
The certified stock continues to drop, but not as fast as the market may have anticipated. As of this morning there were still 766’728 bales in inventory, although this number is likely to decline considerably over the next few weeks. However, the problem the market sees regarding certified stock - as represented by the July contract - is that it has once again become too expensive in terms of cash cotton at 92/93 cents landed and that there is no carry available due to the ongoing inversion. Therefore, even if the certified stock were to shrink to just a few hundred thousand bales over the next few weeks, it would still be difficult to find a taker for whatever remains of this mixed-bag inventory.
Therefore, the potential explosiveness of the July contract is being rapidly diffused as fewer and fewer bets remain open. Open interest in July was at just over 20’000 contracts this morning and this has been reduced further during today’s session. Also, unfixed on-call sales in July amounted to just 5’919 contracts as of last Friday and are probably down to a very manageable level by now. It seems that all the catalysts for a short squeeze are slowly but surely being removed and that July may go out without much fanfare.
In the end all market participants may walk away from the July contract with a smile on their faces. Speculators and Index funds are thrilled because they were able to roll their longs forward at a discount. Merchants are pleased because the strong cash market allowed them to get out of their basis-long positions (sell physicals/buy futures back) at profitable levels, while mills are content that the recent break in prices allowed them to fix the bulk of their remaining on-call contracts at acceptable levels. It is really quite remarkable that despite being sold out of basically all current crop cotton, the market has remained calm and orderly up to this point. And it really doesn’t matter much what happens with the July contract over the few remaining sessions, since the bulk of the open interest has already been dealt with.
It seems like old crop is closing its shop with no inventory to worry about and mills have just enough cotton to get by, while new crop is going to pick up the slack in a couple of months from now. Speaking of new crop, the news in regards to crops around the globe is quite promising at this point, with the exception of China, which seems to have a challenging growing season so far. The US crop had one of its best starts in years and we don’t remember having seen a better Texas crop ever. Although most estimates for Texas are still around 8 million bales, the evidence points to a much bigger crop than that, possibly as high as 10 million bales. Plenty of subsoil moisture, a great start, low abandonment and intermittent rainfall are all combining to what promises to be a record yield this season. We know, a lot can still go wrong, but once the plants are knee high it will be very hard to kill this crop.
We therefore expect the US crop estimate to be raised considerably over the coming months. The USDA currently carries a 16.7 million bales number, but we feel that the US crop has the potential to produce 18.5 to 19.0 million bales. Not only is the planted acreage higher by some 0.2 to 0.3 million acres, but abandonment is much below average at this point and the yield potential for Upland cotton is definitely much higher than 806 pounds.
So where do we go from here? July is basically history and whatever happens from here on will only have a limited impact on the overall market due to the small open interest. The action is now clearly in December, which is struggling to take out the 80 cents resistance level due to heavy grower selling. Unless speculators are willing to throw a lot of money at the long side to overcome all this trade selling, December is likely to retreat from current levels due to the size of the US crop.
Although this may be the fifth season in a row in which world production falls short of consumption, we need to be mindful of the seasonal tendencies. In a couple of months from now new crop becomes available, which will allow the supply pipeline to fill up again. Also, prominent import markets like China, Turkey or Pakistan will have their own crops to feed on, while the US is going to deal with a much larger crop that it has to carry without help from the government. Given the fairly high price level we are currently at, we expect to see some price pressure between November and April, before renewed tightness towards the end of the 2010/11 season will once again act in support of firmer prices.
Best Regards
