“Market Neutral” Report Keeps Bears at Bay – For Now

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Cotton prices found support in the USDA August Supply/Demand Report, as production estimates mirrored those of state specialists first outlined at the New York ICE Cotton Forum on July 25.

While most talked about USDA increasing its estimate of the U.S. crop to 17.5 million bales – one million over last month’s estimate – traders instead focused on USDA’s other “big” numbers (demand and carryover) as they affect the price equation. As such, what most prescribed as a very bearish report has been digested by market forces and determined to be market neutral.

Most likely, the 62 cent price floor has developed enough depth to protect the price from sliding any lower. Yet, still a test down as low as 57 cents cannot be completely ruled out.

Nevertheless, three trading sessions after what was said by most to be a very bearish report, the market – basis December – was within only a very few points of the pre-release trading price. However, any momentum to the topside will likely be slowed on any approach to 66 cents and most likely will find a brick wall at the 67.50 to 68.00 cent mark.

Just as crop stress and weather deterioration will allow for the possible breach of the 67.50 resistance level, good weather will open the door for a test below 60 cents.

A bearish crop report that does not take prices lower typically speaks of a market turnaround. That is not a hard and fast rule, but it’s akin to trend analysis – Never Bet Against the Trend.

Let’s just say for now that the probability of December falling below 62 cents is very small. Supporting this are four facts: (1) the Chinese will halt the selling of Strategic Reserve stock to Chinese mills on September 1 for an unannounced period of time, (2) an increase in demand by Chinese mills, (3) the Chinese new crop movement to mills will be later than usual, and (4) the decline in Chinese futures has stalled.

U.S., Chinese and Indian prices have entered a near equilibrium.

The significant update in the Supply/Demand Report was the reduction in world ending stocks and the increase in world consumption. Additionally, with the one million bale increase in domestic production, U.S. exports were increased 500,000 bales. I would have argued for a 600,000 to 700,000 bale increase in exports, but I take the acknowledgement of increasing consumption as a major victory. The demand response to lower prices is just too much for cotton offtake not to increase even more than currently forecast by USDA.

Exports were estimated at 10.7 million bales. However, carryover stocks were increased to 5.6 million bales – an increase of 400,000 bales. Yet, if a 17.5 million bale crop is realized, prices should support an increase in U.S. exports of 200,000 bales or more, and carryover could be worked down closer to 5.2 to 5.3 million bales.

The report indicates world production was expected to total 118 million bales, with world consumption at 113 million bales. While production will again exceed consumption, the gap was 600,000 bales smaller than last month’s estimates. More importantly however, world stocks outside of China were lowered 700,000 bales.

It was these two estimates that actually gathered the most attention in the cotton trading ring. The reason (as I have become of the habit of mentioning every week) is that China will continue to be a major world importer despite their massive inventory. They need machine-harvested high quality cotton to blend with their strategic Reserve inventory of mostly medium to low grade cotton.

Recognizing this shortage of cotton outside of China, mills stepped in this week and began fixing prices for nearby delivery, as well as first quarter 2015 delivery. This brought the funds back to cotton, as they began to take the long side of the market once again.

Major changes were also made in Indian production (up 1.0 million bales) and consumption (up 500,000 bales). Both the Brazilian and Australian crops were decreased. Since both countries have been good suppliers to China, the market had to find that as supportive to prices.

The state by state breakout of production can be found online.

Most traders are more concerned than usual regarding crop progress going forward. The U.S. and a number of other countries are experiencing unusual weather problems, and the bulls have focused in on the possibility that both U.S. and world production will be measurably short of current estimates. Mother Nature has yet to play her hand in that regard. Nevertheless, it is far too early for growers to do additional price fixing.

Cleveland is a Professor Emeritus, Department of Agricultural Economics, Mississippi State University.
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