NY futures closed the week mixed, as July gained 133 points to close at 82.09 cents, while December dropped 79 points to close at 76.95 cents.
Very strong physical demand for nearby shipment kept the July contract well supported, while new crop December struggled to take out the 78.25 cents technical hurdle and has since retreated somewhat. As a result we have seen the July/Dec inversion widen out to over 500 points again and given the extremely tight cash market it seems unlikely that this inversion will disappear anytime soon.
US export sales were once again surprisingly strong considering that there isn’t that much cotton left for sale, as mills scrambled to fill their requirements for summer shipments. Total sales for Upland and Pima amounted to 425’500 running bales for both marketing years and total commitments now stand at 12.1 million statistical bales for the current season and 1.2 million statistical bales for shipment August onwards. China was the biggest customer with a total of 163’100 running bales.
When we look at the current US balance sheet, we started this season with a total supply of around 18.5 million bales, of which 12.1 million bales have so far been sold for export and 3.5 million bales go to domestic mills by the end of July. However, we estimate that domestic mills will need at least 0.6 million bales from current stocks to tie them over to new crop and that around 0.8 million of the 1.2 million in ‘new crop’ commitments will have to be supplied from existing inventories as well. If our assumptions were correct, it would mean that there are only about 1.5 million bales of US cotton left for sale, of which 1.1 million bales are currently in the certified stock. In other words, apart from the certified stock the US is now basically sold out.
The physical market is reflecting this tight supply situation as we are discerning a greater sense of urgency among mills to find coverage for June/August shipments. Prices paid for high grades on a landed Far East basis are now firmly in the low to mid 90’s and these prices seem to have only one way to go at the moment. The A-index has risen to 90.95 cents today and Chinese prices are in the stratosphere, as the CC index is being quoted at 113 cents (up 15 cents since January) and the CNCE forward market is trading at 124 cents with record volume changing hands. Chinese prices rallied further this week after a winter storm blasted through Xinjiang province on May 16, affecting the young cotton crop of that region, although we are still trying to assess the impact of this unusual weather event.
The bears continue to pin their hopes on the certified stock, believing that this 1.1 million bales lot will eventually force July back in line with December. In a season with plenty of inventory this reasoning makes some sense, but when the certified stock represents nearly all that remains for sale in the US, it should make any July short uncomfortable. What if the certified stock were to suddenly disappear as well? Granted, the bales that end up in the certified stock are usually not the most desirable, but beggars can’t be choosers. China seems to have a voracious appetite for cotton at the moment and the spread between the CNCE and ICE July contracts is currently at 42 cents, which seems to be more than enough to make the certified stock attractive in terms of price. Also, let’s bear in mind that while the certified stock may seem big at 1.1 million bales or 250’000 tons, it represents less than 9 days of Chinese consumption.
We were a bit surprised to see July open interest go up by about 2’000 lots to 105’897 contracts this week. With July First Notice Day only about five weeks away, we should see open interest decline, not go up. We feel that the 10.6 million bales of shorts are playing with fire given the tight supply situation we are in, although they will have an opportunity to get out during the upcoming index fund rolling period, when over seven million bales of July longs will get rolled into December.
So where do we go from here? For the last three weeks the July contract has spent most of its time trading between 80 and 83 cents, unable to break away to the upside but being well supported on weakness. The cotton market has been able to withstand the negative vibes emanating from outside markets and based on the strong physical demand we would not rule out a move higher over the coming weeks. The bearish case is mainly based on the certified stock and if this cotton were to suddenly disappear it would spark an explosive short-covering rally. We therefore feel that it would be prudent for anybody who is still short the July contract to get out of harms way and this includes the 2.1 million bales of unfixed on-call sales.
Best Regards
