NY cotton market marginally up over last couple of weeks (United States Of America)

Plexus Cotton Limited reported that New York (NY) futures continued to trade range-bound since our last report of two weeks ago, with December advancing 205 points to close at 72.63 cents.

The cotton market managed to advance only marginally over the last couple of weeks, despite some dramatic developments in competing crops. Corn and soybeans both traded to all-time highs this week, with corn surpassing 8 dollars/bushel and soybeans trading north of 17 dollars/bushel after the biggest drought in 56 years continued to erode crop expectations.

Although wheat did not reach record levels just yet, it traded at its highest level since August 2008 at 9.36 dollars/bushel. Over 1300 counties in 29 states have already been declared natural disaster areas because of the drought and the count increases daily. Unfortunately there is no major break to this atmospheric high-pressure system in sight until at least the end of July.

The damage to the US corn crop is already of catastrophic proportions since the critical pollination period has passed and there is no longer any hope for a reversal of the situation. Last week the USDA estimated US corn yields at 146 bushels/acre, but sources we trust are placing their expectations at no more than 125-130 bushels/acre at this point.

Also, there will be a much larger than usual abandonment, which will further impact total output. The USDA estimated the crop at 13.0 billion bushels last week, but the way things look we may end up with no more than 11.0 billion bushels.

Soybeans still have a little more time to reverse their dire situation, but with every additional day of dryness and heat the door keeps closing a little more.

The cotton market has so far remained unimpressed by the rally in corn and soybeans. However, we don't believe that cotton can remain immune to this rise in food prices for too much longer.

The problem is that market participants typically subscribe to a static view when looking at the cotton situation, and what they see at the moment is a large global ending stocks number, which looks threatening to prices. What traders should be looking at instead is a more dynamic view of the balance sheet, which factors in the significant changes that will likely arise from the current situation.

Beginning with the Southern Hemisphere crops that are going to be planted later this year and continuing with the Northern Hemisphere crops next spring, we expect to see a significant drop in cotton acreage in origins like Brazil, Argentina, China, the United States and India.

Not only does the current ratio of 18-to-1 between Nov’13 soybeans and Dec’13 cotton make a convincing case for a shift out of cotton, but we also feel that Ag policy in populous countries like China and India will incentivize farmers to produce food rather than fiber next season.

Even without this looming acreage loss, we don’t perceive the current cotton situation quite as bearish as some other commentators. Although last week’s USDA report still has a rather bearish appearance due to its large 72.4 million bales ending stocks number, we need to dissect this report in greater detail to better understand the potential implications on price.

While stocks in China grew by another 500’000 bales to 31.8 million bales, they actually dropped by 2.6 million bales to 40.6 million bales in the rest of the world. Interestingly, despite back-to-back seasons of overproduction, stocks outside China haven’t been changing much over the last two years. In 2010/11, stocks outside China amounted to 37.9 million bales, whereas they are currently projected to amount to 40.6 million bales at the end of 2012/13 - just 2.7 million bales more.

Of course the big change in stocks occurred in China, where we are looking at an increase of 20.2 million bales over the same period. But here is the interesting thing to remember when it comes to pricing - stocks outside China are priced at around 85 cents (A-index), while China’s inventory carries a much higher price tag of over 140 cents/lb.

It is therefore unlikely that China is going to pressure the world market with its high priced inventory anytime soon.  What may happen instead is that China will use its buffer stock to facilitate a gradual shift away from cotton towards food acres. In other words, when these large Chinese stocks are viewed in the context of a dynamic balance sheet, they suddenly become a lot less threatening.

So where do we go from here? The dynamics in grains and soybeans are likely going to propel prices even higher. With Index Funds occupying a large percentage of the longs, with speculators jumping on the long side and with the trade caught short, we could see some silly prices in corn and soybeans before it's all over.

With Nov’13 corn at 6 dollars/bushel and Nov’13 soybeans at 13 dollars/bushel, cotton at current prices will lose out in the fight for acreage next season. Unless food prices drop considerably, which doesn’t seem likely given the current fundamentals, cotton will have to trade higher sooner or later, either by being pro-active in defense of its acreage or by being reactive after having lost a sizeable chunk of its acreage. We suspect it will be the latter!