NY futures came under light pressure this week, as December dropped 138 points to close at 70.71 cents.

The market is a bit of an enigma at the moment, because there seems to be a disconnect between perception and reality. Although most analysts and commentators still have a rather negative outlook on cotton prices based on a statistical picture that sees global ending stocks rise to a massive 79 million bales, the market is acting remarkably resilient.

What caught our attention in this regard was the latest CFTC spec/hedge report, which showed continued strong trade buying and short covering in the week that ended on October 2nd. The trade bought nearly 15Ά000 contracts net futures and options during that week, while large and small speculators took the other side. If we combine that with the 10Ά998 lots that the trade bought the week before, it amounts to nearly 2.6 million bales in net purchases. Why was the trade such a strong buyer of futures and options into this price decline, at a time when we typically see a lot of hedge selling as crops are coming in? Some feel that quality concerns prompted traders to cover shorts in the futures market, while others suspect that a large sale to China might be the reason behind it.

Looking at the latest USDA classing data, there is definitely some cause for concern, since the first 1.63 million bales of new crop yielded just 46.5 percent in tenderable grades. There seems to be an unusually high percentage of high micronaire cotton all the way from South Texas to the Southeast, with classing offices from Corpus Christi, TX to Florence, SC reporting micronaire averages between 4.8 and 5.0. This means that out of 728Ά000 bales classed in Corpus Christi just 49.6 percent are tenderable, while the first 334Ά000 bales classed in Memphis yielded only 38.7 percent.

West Texas seems to be a different story, based on the small amount of 6Ά000 bales that has been classed in Lubbock so far. While the micronaire is mostly in the tenderable range with a 4.1 average, the problem there is staple, as 44.7 percent is shorter than 1.1/32. Although it is still early with only about 10 percent of the US Upland crop classed so far, it looks like the extreme heat and drought this summer have taken a toll on fiber characteristics. We believe that this low percentage of tenderable grades has traders nervous, which may be at least part of the reason for all this trade short covering we have seen in recent weeks.

This morning the USDA released its latest supply/demand estimate and it wasnΆt pretty! Global stocks are now expected to rise to 79.1 million bales at the end of this season, which would be 9.5 million bales more than last season, 30.5 million more than in 2010/11 and 32.3 million bales more than in 2009/10. The only thing that keeps these stocks from pressuring prices more than they already have is the fact that most of this stock accumulation is happening in China. Of the 32.3 million bales in added stocks over the last three seasons, 26.0 million bales belong to China and just 6.3 million bales to the rest of the world.

Apart from the headline grabbing ending stocks number, the changes outside China were actually only mildly bearish compared to last month. Rest-of-the-world production increased by 1.79 million bales, but mill use was up as well, rising by 1.32 million bales. The USDA recognized the fact that record Chinese yarn imports will lead to higher mill consumption in markets that supply the yarn, like Pakistan, India, Turkey, Vietnam, Indonesia and Taiwan.

We believe that the strong rallies in soybeans and corn helped to mitigate the reportΆs bearish impact on cotton prices today. Corn and soybeans both showed less demand destruction than feared and ending stocks for 2012/13 are projected to be at critically low levels. With NovemberΆ13 soybeans closing today at 13.53 dollars/bushel and with DecemberΆ13 cotton settling at 75.02 cents/lb, the ratio between the two has now widened to 18-to-1, which means that cotton is roughly 50% undervalued in regards to soybeans, assuming that a more traditional ratio is in the 11-to-1 or 12-to-1 range.

So where do we go from here? Based on the rather depressing statistics cotton should be selling off, but it isnΆt! This may be due to quality concerns, as the US crop seems to yield less tenderable grades than usual, which makes it dangerous to be the cheapest high grades short. We consider NY futures to be among the most affordable high grades around the globe at the moment. Maybe the balance of the crop will show some quality improvement, which could lead to renewed pressure, but for now there arenΆt too many willing short sellers around as the CFTC report has shown.

Further we need to consider that cotton doesnΆt exist in isolation. With grains and soybeans offering more rewarding alternatives next season, how much lower can cotton go, particularly the DecemberΆ13 contract? If new crop prices start to bottom out, as we believe, they will in turn act as an anchor to current crop prices. Granted, there is not enough carry on the board yet and current crop prices may therefore slip another 3 or 4 cents in relation to DecΆ13, but eventually this backstop should start to work.

Depending on how the quality of the US crop eventually turns out, the market may have some additional room to the downside, but we would be surprised to see values dip below 65 cents. On the other hand, if the lack of tenderable grades persists we could see the spot month retest its recent highs. LetΆs not forget that speculators added a large amount of new shorts over the last few weeks, which sets the market up for a short-covering rally. We therefore see the market in a continued sideways trend between 65 and 77 cents, which has been in force for nearly five months now. A more friendly new crop scenario will eventually come into the picture, but probably not before the beginning of next year.

Best Regards