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Cleveland: Market Rises, Then Slips, Following USDA Report

After spending the week consolidating around 64.50 cents, the December 10 close proved unfriendly, as the market fell over 100 points, dropping down to near the 63.80 cent level.

Mid-week buying, prompted by the December supply demand report, had left the market slightly overbought. Thus, the market forced a limited amount of fund selling below 64 cents. But more importantly, it also uncovered mill buying. Fresh offtake in the 64 cent area should be viewed as a plus to the market and signals a few mills are coming to grips with the fact that cotton availability is, in fact, less than what had been expected.

The recent week had also experienced an increase in open interest from speculative longs as prices consolidated and attempted to move higher. Nevertheless, the cotton trade remains very reluctant to extend their basis long position without more aggressive mill buying.

Additionally, the Thursday sell-off took open interest back below 190,000 contracts, possibly keeping the door open for more back and forth trading in the near term. However, the market has entered the mid-December time period, traditionally the beginning of a month-long period of positive export sales. As noted, mills are showing increased interest, but not nearly to the level of pushing merchants to improve basis offers or price offers to growers. Nevertheless, as noted last week, mills are very thinly covered for the first quarter of 2016 and near totally void of any coverage in the out months.

Thus, the market is set to crawl higher, backing and filling along the way, but with a positive upward bias.

The market Roundtable group, discussing the USDA December supply demand report, offered a wide array of price expectations, from a low to 61 cents to a high of 77 cents for the New York ICE March/May/July contracts. This was significant in that the group’s typical range is only some seven to ten cents from the low to the high, and generally all in the group offer a similar price forecast.

This week’s discussion provided the first disagreement of analysts’ opinion for the first time in well over a year. That should be viewed as healthy for the market, as it reflects a change in market fundamentals – something not observed for the past twelve months (it is a bit early to discuss the 2017 contracts, but it should be noted that some did establish life of contract highs this past week and were hovering near 67 cents – all initial signals of changing fundamentals and the hoped-for move to profitable prices).

As foretold, USDA lowered the U.S. crop 300,000 bales – down to 13.0 million bales – and lowered ending stocks to 3.0 million by reducing exports from 10.2 to 10.0 million bales. My thoughts are that the U.S. will eventually ship 10.2 million bales, as non-Chinese consumption is stronger than USDA numbers reflect. USDA reasoned that the smaller U.S. crop would generate fewer exports, but the market will likely prove otherwise.

Actually, USDA itself hinted at this by increasing world trade one million bales, now up to 35.35 million bales – an incredible one month leap. Yet, in a very surprising move, it lowered the U.S. share of trade. The increase in world trade is based on the rapidly expanding consumption outside China. This has been led by Bangladesh, as well as Vietnam and other Southeast Asian countries – all major buyers of U.S. cotton. Thus, U.S. carryover can easily fall to 2.7 to 2.8 million bales before price rationing would limit exports.

Supporting this, USDA also lowered world carryover outside of China to 37.5 million bales – the lowest level since 2009-10 and the second lowest in some 15 years.

World Production was lowered by 1.92 million bales, world consumption was reduced by 200,000 bales, and the resulting world ending stocks were lowered by 1.7 million bales. A multitude of other changes included production declines in Central Asia (170,000 bales), Turkmenistan (125,000), China (700,000), Greece (100,000), Turkey (150,000), and Pakistan (1.0 million bales). Production increases were in the African Franc Zone (100,000 bales) and Australia (300,000 bales).

However, future reports could see the Indian crop as much as 1.0 million bales lower, Pakistan another 400,000 lower, and the Brazilian crop 200,000 lower. Too, look for the U.S. crop to be 50,000 to 100,000 bales lower. Thus, world ending stocks will see further significant reductions.

These changes mask the significant shift in cotton trade around the globe. China is no longer the world’s leading importer of cotton. That crown has now transitioned to Bangladesh, but even that will be short lived. Vietnam, either in 2016 or 2017, will be the undisputed holder of the crown. Nevertheless, China will still import 12.5-13.0 million bale equivalents of cotton yarn.

Current USDA estimates include a world carryover of 104 million bales. This compares to beginning stocks of 112 million, or an 8.0 million bale reduction so far this season. Before all is said and done, look for final 2015-16 world ending carryover to be down another 1.5 to 2.0 million bales, a net reduction of 10 million bales. A 100 million bale carryover is difficult to refer to as bullish, but a near record low carryover net of China can be.

The market will drift higher. But yet, there are a few more teeth to be pulled. Growers are advised to move cotton in the cash market and purchase a three cent out-of-the-money July call option, while selling a three cent out-of-the-money July put option on a one-to-one basis.

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