NY futures continued to climb higher this week, as December gained 475 points to close at 101.92 cents, while March rallied 408 points to close at 100.46 cents.
Although the general price trend is still up, we have been seeing a much more two-sided and volatile trading pattern over the last couple of weeks. Although December had another strong showing this week, it closed today nearly four-and-a-half cents off its recent high of 106.40 cents. The same goes for October, which posted a high of 109.10 cents on the weekly continuation chart, a level that may be difficult to overcome in the near future.
US export sales of Upland and Pima cotton were once again stellar last week, as they came in at a marketing-year high of 791’800 running bales for the current season, while another 50’600 running bales were added for 2011/12. This brings total commitments for the current marketing year to 9.3 million statistical bales, or 60 percent of the USDA’s projected export number of 15.5 million bales. By comparison, last year at this time export commitments stood at just 3.7 million bales, or 5.6 million bales less than now.
Interestingly though, the US has shipped only 1.5 million statistical bales so far, which is more or less the same amount as last season. The reason behind this slow pace of exports is a lack of available supplies, since we started the season with stocks of just 3.0 million bales. The current pipeline shortage has grown to a never before seen level, since domestic mills have contracted most of the 3.5 million bales they require for the season, while export sales have been on a tear with 9.3 million bales already committed.
However, this empty pipeline is starting to fill up fast since the US crop is generally early and continues to move off the field at a very rapid pace. The bulk of the Mid-South crop should be harvested in a week or two, while picking is gaining momentum in West Texas. Only the Carolinas suffered a setback this week after two storm systems dumped copious amounts of rain on an open crop. Wilmington in North Carolina received over 20 inches of rain since Sunday, which will lead to both yield and quality losses. Looking at the big picture though the crops in the Carolinas and Virginia account for just about 1.3 million bales, or about 7 percent of US production. Georgia, which at 2.3 million bales is the biggest producer in the Southeast, narrowly escaped these storms and received only minor precipitation.
As we have previously stated, it does not make sense to us to see this market go a lot higher as we head into harvest. With roughly 100 million bales coming into the global pipeline over next three months, the timing for a further spike in prices doesn’t seem right. The panic has primarily been caused by traders and mills trying to secure future supplies for fear of not being able to do so later on, which has squeezed a lot of forward demand into this period of tight supply.
But let’s not forget that nearly all of this cotton that has been contracted so feverishly at these elevated prices has yet to be ginned, shipped, spun, turned into textiles and sold to consumers. In a way the tail seems to be wagging the dog, because these high prices may lead to substantial demand rationing and thereby preempt the expected shortage at the end of the season.
If prices remain high enough to lead to rationing and substitution down the road, we wouldn’t be surprised to see a drop in mill use of some 5-8% over the course of the season. In China, where cotton prices have rallied beyond 150 cents/lb this week, they are now nearly twice as expensive as polyester staple fiber. This is simply too much of an incentive to ignore! We are already getting anecdotal evidence from several Asian markets that mills are either trying to shift into finer counts or that they are adjusting their blends in favor of man-made fibers.
At the same time these high prices are attracting additional acres into production, starting with the Southern Hemisphere crops that are about to be planted. Both Brazil and Australia are showing a lot of enthusiasm for cotton at the moment and we expect their planted acreage to increase beyond current expectations. The same is likely going to happen in the Northern Hemisphere next spring if the market remains strong.
In other words, global production numbers may start to trend higher, while world mill use is likely headed in the other direction. The latest USDA supply/demand estimate has world output at 117.0 million bales, while mill use is at 120.5 million, but it doesn’t take that much of a change to see these numbers reverse. For example, if world production were to go up by just 3%, while demand declined by 3%, we would go from a 3.5 million bales deficit to a 3.5 million bales surplus.
However, while the market is currently doing its job to correct the seasonal output gap that has existed for the past five seasons, it will probably take more than one season to rebuild stocks to a more comfortable stocks-to-use ratio. First of all, we believe that global beginning stocks were a lot lower than the 47.0 million bales the USDA has in its balance sheet, mainly because we feel that China didn’t have 18.8 million bales on August 1. The real stock number for China is probably closer to 14 million bales, which would bring global beginning stocks down to around 42 million bales. This would explain why the market has been acting like it was running out of cotton lately. In order to bring the market back into a more balanced position, stocks would probably have to rise back above 50 million bales.
So where do we go from here? We still feel that once the crop is in, the market will start to settle down into a trading range - somewhere between the low 90’s and low 100’s – while volatility drops and intra-crop carrying charges make a comeback. Although the upside may be limited for reasons outlined above, we also believe that there is going to be tremendous support underneath the market. China’s government has just released another 400’000 tons of its reserve, which means that it will have to start refilling these stocks the next chance it gets. This should put a strong bid under the market for the remainder of the season, along with the 10.6 million bales that mills still need to fix.
Best Regards
