NY cotton futures rebounds last week

Plexus Cotton Limited reported that New York (NY) futures rebounded this week, as December gained 169 points close at 75.22 cents.

A week ago the December contract looked like it was ready to fall apart after it pierced through a 3-month uptrend line, but a wave of euphoria following the Fed announcement lifted values back above the trendline, thereby negating a potential breakdown for the time being.

However, even though last Friday’s 237-point rally may have looked impressive, volume was once again not convincing, averaging just around 14’000 contracts for the week, while open interest remained stuck at around 182’000 contracts.

Rather than new buyers entering the market, which would have been constructive, it was primarily a lack of selling that allowed the market to move up a few cents, as spec shorts pulled back due to the Fed and trade sellers were holding off after additional rain threatened crops in the Mid-South earlier this week.

However, with the entire cotton belt enjoying nice weather at the moment and with the forecast looking promising as well, harvest should make good progress in the days ahead. This in turn should start putting some pressure on prices, as a large part of the US and other Northern Hemisphere crops remains unsold.

US export sales amounted to 211’300 running bales of Upland and Pima last week, with China once again being responsible for the lion’s share. Total commitments for the season now amount to 5.4 million statistical bales, which compares to 6.9 million bales a year ago. In other words, there are 1.5 million bales fewer sales on the books, yet the crop is expected to be 1.5 million bales larger, which means that the US has its work cut out to find a home for all these bales, especially since China may no longer be there as a big importer.

This week the NDRC announced that there wouldn’t be any additional import quotas issued this year. China has apparently chosen to bridge any gaps to new crop by selling bales from its reserve stocks rather than letting additional imports in. So far the Reserve has sold just over 300’000 tons or about 1.4 million statistical bales. These sales will be suspended on September 29, by which time there should be enough new crop cotton in the pipeline to guarantee a steady stream of supplies.

The decision to force mills to use high priced domestic cotton instead of much cheaper imports will further suppress mill use in China. However, while Chinese textile mills are finding it increasingly difficult to compete internationally, mills in the rest of the world are benefitting from it, both in terms of better margins and higher market share.

So where do we go from here? Although we are mindful of the long-term bullish implications resulting from the unrestrained money printing by central banks and we also still assume that there is going to be a significant drop in cotton acreage next season, we nevertheless remain negative on prices over the next 2-3 months.

There are simply too many bearish factors adding up to a lower price forecast at the moment. First and foremost, we expect harvest pressure to build over the coming weeks.

What are the owners of new crop cotton going to do when Chinese buyers remain in hiding and the market offers less than 400 points carry between Dec 2012 and Dec 2013? Holding on to inventory and wait for better days doesn’t sound like a winning strategy to us.

Why risk losing 10 cents to a potential drop in the market and pay carry on top of that if one can instead sell the cotton, stop the carry and buy a relatively inexpensive call spread to participate in an up move?

Also, a strengthening US dollar and somewhat weaker soybeans and corn prices are not helping the bulls’case at the moment. We therefore feel that as soon as new crop bales start piling up in warehouses, both the cash and futures market should experience some selling pressure.

The cash market will only be able to absorb a limited amount of supply due to the continued hand-to-mouth buying by mills, which means that most sellers will have to turn to the futures market for price protection.