NY futures continued to move sideways this week, with December edging up 51 points to close at 102.73 cents.
Over the last eleven sessions the December contract has traded in a very narrow band of just 534 points, between a low of 98.21 and high of 103.55 cents. On a closing basis the range has even been tighter at just 352 points, between 99.21 and 102.73 cents. The market has now moved sideways for exactly three months and it closed today near the midpoint of this longer-term range, having almost no momentum.
What will it take for the market to wake up from its comatose state? Bearish forces are currently kept in check by the Chinese Reserve, who is ready to buy cotton at a price that equates to just slightly below a dollar in terms of NY futures. The Reserve has so far not been able to procure any cotton yet, since the trade has been stepping in front of this proverbial line in the sand by absorbing early arrivals in China as well as imports.
Whether this support price will be strong enough to withstand increasing pressure from Northern Hemisphere crops over the coming months remains to be seen, but we estimate that the Reserve will probably want to rebuild its stocks to at least three months of domestic mill use, which would equate to around 11-12 million bales. Current stocks are estimated to be no more than 1.0 million bales. Although the buying will likely be spread out over a couple of seasons, this additional ‘demand’ will definitely help to offset pressure from a production surplus this season.
The upside still looks limited as well, because harvest is now gaining momentum and supply is likely going to be plentiful over the coming months. India (6.1 million tons) and Central Asia (1.4 million tons), along with a number of foreign growths (African origins, Australia, Brazil, Greece), are harvesting big crops this season and will substitute for missing Texas high grades.
The US currently has export commitments of 8.0 million statistical bales, of which only about 1.0 million bales have so far been exported. This means that there is still a lot of cotton to come out of the US, sold or unsold. US merchants are currently trying to figure out their quality position, because the US crop presents a very mixed bag of good, bad and ugly cotton against commitments of mostly premium grades. We have already seen a lot of shuffling and substituting in recent weeks and it is still going to take a while before shippers have an accurate picture of their position.
However, we expect the unsold surplus to consist mainly of odd lots with shorter staple and/or high micronaire, some of which may end up on the board, especially if the futures market were to offer prices above the cash market. Unlike last year, when the certified stock consisted primarily of A-index styles, it is shaping up to look more like a B-index contract this season. Just how many of these off-grades will be tenderable still depends to a large degree on the weather. While the dry and hot summer affected mike and staple, we now have rain that is threatening to render some of this cotton too low for certification. West Texas is expecting a low-pressure system to bring widespread precipitation to the area Friday and Saturday, with rainfall totals of 1-2 inches in most locations. While this is generally good news for the drought-stricken area, it comes at a very inopportune time, since the crop is open and vulnerable.
So where do we go from here? Cotton fundamentals look fairly well balanced to us at the moment, with mill use plus Chinese Reserve buying more or less matching production this season, which argues for a continuation of the current sideways trend. We therefore need to look outside the cotton market for potential catalysts to break out of this range. The most obvious is another meltdown in the financial markets, stemming from a sovereign debt default or a banking crisis.
Although we believe that the global financial system is in serious trouble, the preemptive strikes that have recently been launched by policymakers and central bankers may postpone the day of reckoning by a year or two. Also, unlike in 2008, investors are expecting the worst and have already trimmed their positions quite considerably and raised cash in the process. This makes another deleveraging phase like three years ago unlikely. Just look at the latest CFTC report, which shows large specs/hedge funds at just 1.7 million bales net long (3.0 million gross long and 1.3 million gross short), while index funds are 4.8 million bales net long. These positions are less than half of what they were three years ago.
With everyone playing defense at the moment, hunkering down in ‘risk off’ mode, the surprise may actually come from a return to a more aggressive investment stance by money managers. The world is currently awash in liquidity, which is parked mainly in the bond market. However, this money is being punished by negative real interest rates (nominal rate minus inflation) and sooner or later there will be a renewed appetite for ‘riskier’ investments, such as commodities. And since commodity markets are relatively small in the overall scheme of things, it won’t take much to get the ball rolling. Until that happens though, the market will likely remain stuck in the sideways pattern it is currently in.
Best Regards
