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Plexus: Market on Firm Footing Through Harvest

New York futures moved slightly lower this week (ending October 16), as December dropped 38 points to close at 63.56 cents/lb, while March gave up 56 points to close at 61.71 cents/lb.

Another round of severe weather in the Delta and Southeast, combined with some additional spec short covering, lifted December to a high of 65.65 cents earlier in the week. But improving weather conditions and renewed economic worries precluded any further advances for now.

Last week’s CFTC report confirmed that it was spec short covering that lifted December nearly 500 points off its lows, while the trade used the opportunity to expand its still meager net short position. During the week ending on October 7, the trade increased its net short by 0.9 million bales to 3.4 million bales, while speculators reduced their net short by the same amount to 2.4 million bales. Index funds remained 5.8 million bales net long.

Interestingly, the change in the trade’s net short position was mainly the result of trade long liquidation rather than new shorts, which probably means that merchants were finally able to get some cotton out of grower hands. However, the flow of cash cotton into the marketing channel remains rather slow at this point, as only 2.1 million warehouse receipts have so far been issued.

Fortunately, the weather is looking quite favorable at the moment, and harvest should gain momentum over the coming weeks. Nevertheless, a somewhat irregular growing season and several rounds of heavy rain in recent weeks have shippers concerned regarding quality. It will still be another 4 to 5 weeks before we have a clearer picture as to what kind of a crop we are dealing with.

The October 10 USDA supply/demand report played right into the current market scenario, with a short-term bottleneck situation eventually giving way to a longer-term oversupply outlook. The USDA lowered the U.S. crop to 16.26 million bales. That reduced total supply for the season to 18.7 million bales, of which more than half is already committed to domestic and overseas buyers. This creates even more urgency among merchants to get their hands on premium cotton early on.

However, the USDA numbers leave no doubt that the rest of the world (ROW) should sooner or later transition to a substantial oversupply situation. The USDA estimates that ROW stocks will grow from 38.6 to 45.0 million bales over the course of this season. The U.S. and India will shoulder the bulk of this inventory build-up, seeing their stocks rise by 2.45 and 2.30 million bales, respectively, followed by increases in West Africa (0.55 million bales) and Central Asia (0.52 million bales).

In the Northern Hemisphere stocks will probably start to build from January onwards, and we expect the market to reflect carrying charges between March and July futures in order to provide an incentive for merchants and/or growers to hold inventory.

This increase in ROW stocks is the result of a 13.19 million bales production surplus, which is only partially absorbed by Chinese imports of 7.0 million bales. That’s quite a change from last season, when a 12.94 million bales surplus was more than offset by 14.12 million bales in Chinese imports.

This slowdown in Chinese imports will most likely be felt after the turn of the year, because China is currently still chasing after some hard-to-find high grades to fill existing quotas before the end of December. In other words, the cotton market may feel a “double whammy” in January when ROW stocks are beginning to accumulate while Chinese imports are starting to slow down.

Unsettled financial markets added another twist to the cotton story this week, as stock markets around the globe went into corrective mode and the 10-year Treasury yield dipped below two percent. Markets don’t like uncertainty, and there is plenty of it at the moment between an explosive Middle East, the Ebola threat and some soft economic numbers. However, while a deflationary shock is certainly possible in the short-term, we shouldn’t discount the power of the Fed and other Central Banks, since they will fight deflationary forces tooth and nail with more money printing.

Therefore, to bet on collapsing asset prices is to bet against the Fed, which is not a winning proposition in our opinion. Unlike in the past, when Central Banks were the lender of last resort, they are now the buyer of last resort, and they basically have unlimited powers to print money in order to bid up asset prices such as stocks and real estate. It is more than a bit ironic that creating inflation has suddenly become the stated goal of Central Banks.

So where do we go from here?

Although the latest countertrend move seems to be over, December should remain on relatively firm footing until the bulk of the U.S. crop has been harvested and the quality composition is known. Once December is off the board and inventories are beginning to build, the board is likely to come under further pressure, and we should also see carrying charges appear between March and July. Various government support programs may slow and/or delay the decline, but it is difficult to envision anything but a sideways-to-lower market going forward due to the massive global inventory, some of which is now starting to switch back to the ROW.

 

THE ABOVE IS AN OPINION, AND SHOULD BE TAKEN AS SUCH. WE CANNOT ACCEPT ANY RESPONSIBILITY FOR ITS ACCURACY OR OTHERWISE.

Source – Plexus

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