By Brendan Conway
The cotton harvest is behind schedule and ICE warehouse stocks are at a 17-year low. None of that moves Citigroup commodity strategists, who argue in a note that the rally “might be full of fluff.” ItΆs a caution for investors tempted to buy one of a few highly specialized funds and exchange-traded notes that could benefit from a rise in prices.
The fluffy commodity started to pick up pace in the last few sessions after moving only a bit off its mid-year lows over the summer. Today, futures are up by more than 3% as the supply worries grow. The iPath Dow Jones UBS Cotton Subindex Total Return ETN (BAL) is up 4.4% as of midsession Wednesday andthe RICI Agriculture ETN (RJA), about 12% cotton, is ahead by 1.1%. The more diversified PowerShares DB Agriculture Fund (DBA), with only a few percent of the portfolio invested in cotton futures, is ahead by 0.3%.
For CitiΆs Aakash Doshi, Edward L. Morse and three of their colleagues, itΆs no time to change course:
Driving home todayΆs market has been data showing slight delay in the harvest that is currently 6 percentage points behind pace y/y although relative progress is largely in line with the 5Y seasonal average of 30%. This was also coupled with some reduction in cotton crop quality (about half the US cotton planted acres are in Texas which were initially less impacted by US drought this summer but recent reports indicate the crop quality has diminished as well). Why does this matter? In large part because ICE certified stocks remain precipitously low and only US grown bales can be delivered to the five warehouse locations across the States. Combined with weather factors, this delivery issue had kept funds at bay from getting too bearish the market during the summer and early September and why prices have generally rebounded after slipping below USd70/lb (particularly when considering the likelihood of only a few physical houses as the dominant holders of US inventory at the moment). These certified stocks have continued to slide to seasonal lows. But as the US cotton crop comes online and the harvest progresses into mid-November, certified ICE stockpiles are biased to build—and build quickly.
Expectations for weak Chinese demand is another reason for caution:
China remains the key global cotton consumer and in the absence of a reserve purchase program that the Middle Kingdom ended in 1QΆ12 there is likely to be limited upside (during 11/12 China imported in excess of 23mbales but this figure is likely to drop by more than half in 12/13). To be sure, imports have been creeping steadily lower m/m since this past spring. As such the global cotton balance sheet appears bearish under most circumstances (unless there is a surprise stockpiling in Asia although the impetus with sluggish global growth and mills switching to synthetics from last year doesnΆt seem to be point to this development). Even with stronger consumption and lower US production, China is looking to end up with nearly half of 12/13 carryout.
