Rabobank is bearish on the short-term outlook for cotton futures, saying a recent rally had outpaced the fundamentals of the market.

Rallying cotton prices, and relatively stable yarn prices "should incentivise mills to use more man-made fibre in order to maintain margins", the bank warned.

But the bank remains long-term bullish on cotton value, citing the looming production deficit of the fibre.

Short term correction

"Cotton futures exceeded all expectations through July, adding 12% month-on-month, breaking out to two-year highs above 70 cents a pound," Rabobank said. 

The bank revised upward its cotton price outlook, to account for the recent rally. 

"In the near term, we expect prices to settle back to the 71 cents a pound mark as extensive buying runs out of steam, on speculative profit taking, farmer selling and a demand response from global spinners turning to alternative fibre," the bank said.

And Rabobank forecast prices to recover only as far as 73 cents a pound by the end of the year.

October cotton futures in New York at currently trading at 74.46 cents a pound, while December cotton futures are at 74.43 cents a pound.

Fibre competition

One factor weighing on cotton prices is the low cost of competing fibres.

Synthetic fibres are "increasingly competitive, at around 50% the value of raw cotton".

And the widening premium of cotton to synthetic fabric could encourage mills to include more of the latter in their yarns, Rabobank said.

Bullish fundamentals

But Rabobank noted "a number of bullish factor," including heightened Chinese mill appetite, a bullish July Wasde, and concerns over Indian and Pakistan acreage".

"Global fundamentals—particularly the onset of a second consecutive deficit year—remain supportive of prices, which are projected to trend up, to 74 cents a pound by mid-2017," the bank said.

July 2017 cotton futures are currently trading at 73.72 cents a pound.

Weather drives risk

Weather in the northern hemisphere growing regions, including southern US, India, and Pakistan, will drive volatility in the months to come.

"Texas is expected to receive hot, dry weather in the 6-14-day period, which could have a large negative impact if sustained," Rabobank said.

"Furthermore, the IMD maintains rainfall totals across Gujarat, the major Indian producing region, of below 50% of normal," the bank noted.

These moisture deficits are expected to improve, but weather risks will "drive price swings in a tightening global supply environment".