New York futures moved sideways this week (October 23), as December dropped 52 points to close at 63.04 cents/lb, while March gained 17 points to close at 61.88 cents/lb.
The main feature this week was the drop in volatility, as the market is discounting a scenario in which prices are not expected to change significantly over the coming months. December and March volatility both dropped around two percent for at-the-money options this week, with out-of-the money strikes seeing even bigger declines.
This is telling us that traders expect the market to remain “boxed in” between relatively strong support and resistance. Such an outlook seems certainly plausible when we look at the current fundamental and technical picture.
From a fundamental point of view, the market is still in the process of transitioning from an empty pipeline to one that may overflow in a few months’ time. However, various government support programs, like the U.S. loan or the Indian MSP, are likely to delay or mitigate the negative impact of these excess supplies.
Although China is expected to import only about half as many bales as last season because of fewer import quotas available, we cannot rule out that additional quantities will find their way into China if an arbitrage opportunity between international and Chinese prices opens up.
The cheapest quotes in the A-index are currently at around 69.00 cents, which translates into roughly 15,000 yuan/ton at the full 40 percent import tariff, for which no import quota is required. That price compares to a current CC index of around 14,800 yuan/ton and forward prices for January delivery of 13,900 yuan/ton (CNCE) and 13,800 yuan/ton (ZCE).
While international prices currently can’t compete against Chinese values, they are not too far out of line. If international prices were to fall another 5 cents (let’s say to 64 cents), it would equate to around 13,900 yuan/ton and potentially allow for imports at the full tariff – provided, of course, that Chinese domestic prices maintain their current level.
Another numbers game exists in India, where the CCI has started to lift some cotton from farmers at the minimum support price (MSP), which calculates to around 67/68 cents ex-gin at the moment. If the CCI were to take some 5 to 7 million bales off the market over the next few months, it would probably prevent any major price pressure during that time frame. This may even open the door for imports from West Africa, since mills in the south of India may find it cheaper to import cotton than buying it from the north.
Not too long ago, the market was of the opinion that prices would come under substantial pressure once the Northern Hemisphere crops are in. But due to these price support and arbitrage scenarios, it now looks more like a slow grind lower.
The best chance for the market to rally lies with the large spec short position. Although the net spec short position amounts to only 1.7 million bales at this point, outright shorts are at 7.4 million bales if we consider both large and small speculators.
Speculators like to be in trending and momentum driven markets, which was the case when cotton dropped from 85 to 62 cents between early May and late July. However, since making a low of 62.02 on August 1, cotton has been moving mostly sideways. We therefore would not be surprised if speculators were to cash in their shorts in order to try their luck in a more exciting market. An exodus by spec shorts could lift prices by several cents, but the trade would most likely be there to sell into strength and therefore keep any breakout attempts short-lived.
Any sustained recovery in cotton prices will have to come from an increase in demand. With cotton prices once again competitive against polyester, we believe that this is starting to happen. But, it will probably be a slow process and take several years to make an impact, considering how large global inventories are.
With Western Economies struggling at the moment, the charge has to come from Asia. India is currently the bright star as far as economic growth is concerned, but even China looks a lot better to us than what some of these gloomy headlines want us to believe. For example, for the first nine months of the year, real per capita disposable income rose by 8.2 percent, which bodes well for retail consumption going forward. While China has its problems, mainly due to an overextended real estate market, consumers are still going strong.
Although China’s GDP has been slowing down in recent years, the current growth rate is still quite impressive. While a 7.3 percent growth rate may be the lowest in five years, China’s economy still increases by about the size of Indonesia or Turkey’s GDP every year. China’s economy has grown more than five-fold in the last 10 years. And earlier this month, the IMF reported that by one measure – the “Purchasing Power Parity” (PPP), which adjusts GDP for the cost of living – China has now overtaken the U.S. as the largest economy in the world.
So where do we go from here?
The market seems to be frozen in place at the moment, with the March contract currently trading at an 8 cents discount to the A-index, which represents more or less “fair value.” December still carries a small premium given the nearby supply shortage, but that may fade away over the next few weeks since harvest in the U.S. has been making great strides, with no adverse weather in sight anytime soon.
Once the crops are in and sorted out, we may see renewed pressure on cash prices, which, in turn, would allow the futures market to move lower as well. India holds the key in this regard, since it has the largest amount of unsold cotton in the rest of the world (ROW), and government purchases may be able to hold values stable for a while.
Short-term rallies are possible if speculators were to get out of shorts, but prices won’t run far because the trade will be there to cap them. In the longer term, the market still looks heavy to us, although it may take longer than expected for price pressure to materialize.
THE ABOVE IS AN OPINION, AND SHOULD BE TAKEN AS SUCH. WE CANNOT ACCEPT ANY RESPONSIBILITY FOR ITS ACCURACY OR OTHERWISE.
Source – Plexus