NY futures move sharply higher

NY futures moved sharply higher this week, with July rallying 1321 points to close at 164.24 cents, while December gained 1266 points to close at 139.23 cents.

Memorial Day weekend has come and gone without bringing any significant relief to the drought-stricken areas of West Texas. Apart from a few isolated thunderstorms the region has remained mostly dry and the 7-day forecast doesn't look too promising either. With no rain in sight and insurance deadlines approaching, many dryland acres will not get planted this season, but it is not just dryland that has traders worried. Above average temperatures accompanied by strong and persistent wind have affected irrigated fields as well, although it is too early to assess the impact.

Growers in the Mid-South and Southeast had to contend with an array of problems as well, as some areas received way too much water, while others didn't get nearly enough, plus there were issues with insects and damage from strong wind and hail. Overall the US crop is off to a rocky start and production expectations will therefore have to be adjusted lower. It is difficult to estimate where exactly the US crop stands, because there is still time to rectify some of the problems, but unless we see an immediate improvement we are afraid that the US crop won't yield much more than 16.5 million bales.

The outlook for a smaller US crop will have implications on the export front. Unlike in previous years, the US has already committed around 5.8 million statistical bales for export next season, which compares to just 1.4 million bales of forward sales a year ago. Combined with the 3.8 million bales in domestic mill use, the total number of bales owed is therefore approaching the ten million mark or roughly 60% of potential production.

This means that shippers will be forced to step on the breaks in regards to additional sales, until the quantity and quality of the coming crop are known. As a result US export sales are likely to 'disappoint' over the next few months, but that will be mainly due to a lack of available offers rather than a lack of willing buyers.

Other origins will have to pick up the slack, but many of them don't have the same logistical capability as the US. While the US is able to ship 400'000 to 500'000 bales in a week, movement out of the CIS, India and other potential exporters tends to be a lot slower and cumbersome. Therefore, mills that have yet to cover third and fourth quarter requirements would be well advised not to wait too long before doing so.

The big de-certification of nearly 143'000 bales reduces the certified stock to just 52'035 bales, its lowest level since November 19 last year. This is likely to make many of the remaining 63'431 shorts in July quite nervous, especially since new crop doesn't look that great at the moment. Merchants who own current crop inventory may want to hold on to it as 'insurance' against a potential shortage of new crop high grades.

That being said, at the right price we may still see some of the carry-over stock end up on the board, but for now anyone who is short July and doesn't have the cotton to back it up, will likely have to pay his way out of it. This includes the still 1.85 million bales in unfixed on-call sales in July, against most of which merchants carry futures short positions.

Yesterday's big jump in December open interest of 4'263 contracts signals renewed buying activity by speculators. With Ag commodities in a weather market, speculative interest is once again high. It was less than a month ago when the CRB-index took a big hit from deleveraging after exchanges raised margin requirements on several commodities in order to reign in speculators.

However, while margin increases may temporarily derail an uptrend in commodities, they are unable to override bullish fundamentals. This week December corn traded to a new contract high of 6.95 dollars/bushel, while November soybeans closed at 13.93 dollars/bushel, just 4 cents shy of their February 9 contract high.

Many cotton traders still believe that prices will eventually have to fall back to their longer-term average. Although nothing is impossible, we see this as highly unlikely. With a bushel of corn at 7 dollars and soybeans at 14 dollars, cotton has its work cut out to stay competitive. Just look at what happened this spring, when cotton wasn't able to attract more than 12.5 million acres in the US despite a spot price that was three times the historical average. Had corn and soybeans traded at levels of five years ago (2-3 dollars for corn and 5-7 dollars for soybeans), cotton would have seen its acreage go up by several million acres more.

In other words, we cannot look at cotton in isolation but have to view it in the context of the entire Ag complex. As long as food prices remain high, cotton will have to be attractively priced as well. A growing world population and rising protein consumption combined with the fact that more food is being used to produce energy and to feed livestock should all but guarantee that corn and soybean prices will remain at elevated levels for years to come.

So where do we go from here? The large de-certification should keep July shorts on the run, while December continues to be supported by a troubled US crop. Physical prices have continued to struggle despite the rally in New York, as mills are still in the process of adjusting their pipeline inventory.

However, there are some positive signs emerging from the yarn market, as prices seem to finally be stabilizing. Going by recent retail sales reports from various economies around the globe, end-user demand seems to be stronger than what the current statistics are suggesting, which means that the expected production surplus may end up being a lot smaller than projected. New crop prices have probably gotten a bit ahead of themselves after December has rallied by over 25 cents since May 13 and we may therefore see a consolidation phase, but given the state of the US crop we believe that any dips back to the 130 level or below should be used as a buying opportunity.