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Cleveland: Quality Premiums Are Coming

Both the old crop May and July contracts, as well as the new crop December contract, are all hovering between 56.50 and 57.00 cents. Speculative funds tend to be more nervous with this type of trading scenario. However, the funds have not cut and run as yet. But, look out for this week. A decline in open interest on trading above 57 cents will note that they are bailing out.

Nevertheless, the Chinese situation sits like a lead cap over the market. The Chinese cotton authorities have been masterful in leaking official information on a piecemeal basis, offering only tidbits of official information at any one time – and just enough to keep a bearish perspective on the market.

As we have commented since December, the heavy selling on the Chinese exchanges has led New York lower. But short sellers in the Chinese market at midweek got caught in a delivery squeeze – not having enough cotton on hand to make deliveries against futures contracts. It should be noted that the outside trading day on the New York ICE corresponded with the Chinese delivery squeeze. Thus, with the New York May and July contracts both closing over 57 cents this week (December’s close was just short), the market should look for as much as a two cent gain on the week.

The USDA March supply demand report was as expected. World carryover was reduced about one million bales, mostly on the strength of USDA’s decision to finally lower the Indian crop. This one million bale reduction could be followed by as much as another 500,000 bales by July. There were other minor changes in other countries.

More importantly, the USDA weekly export sales report contained important news that has seemingly gone unnoticed. While most have discussed the excellent sales of 200,900 bales (185,100 RB of upland and 14,900 RB of Pima), the real news was who comprised the set of buyers. The usual suspects, Vietnam and Turkey, were major buyers. However, the second largest buyer was Brazil with 23,200 RB.

Brazil is not just a competitor of the U.S. in the world export market, but a major-major competitor. The tariff/import fees to import U.S cotton were substantial. It signals our previously discussed theory that Brazil is out of quality cotton, and most countries must now look to the U.S., Australia (if they can find any), West Africa and a few very small suppliers for quality. Australia has only a limited supply, and substantial sales of African were made this week.

The quality premium for U.S. growths is on the horizon. Hold for it. The premium for U.S. quality has been stable, but should now improve substantially with time. Export shipments recorded a marketing year high of 262,500 RB, with Upland totaling 252,100 bales and Pima at 10,400 bales.

Another plus on the fundamental side in the export sales report was an increase in 2017 sales – an indication that mills are developing a more friendly business attitude toward yarn future business. This may be nothing more than a small nail, but it could be another nail in the bear’s coffin. Until cotton can halt its skid versus chemical fibers, I cannot get too excited. But some good news was needed.

Yet, another concern is that the USDA 9.4 million acre plantings forecast for 2017 is gaining traction. I have flip-flopped back to that estimate, as the continued moisture in the Cotton Belt has halted corn planting and cotton will gain acres versus corn intentions. Texas was already in the books for a strong increase in cotton. Now, the south Delta is close to having to abandon ideas of corn in favor of cotton.

Additionally, cotton is very kind to the soil, and fertilizer costs will be much less than typically budgeted. Thus, the cash flow statements look much better to lenders. Growers will come forth with nitrogen. But in years like this, they typically use only nitrogen, abandoning the other fertilizers. Thus, production cost for many will be much less than initially forecast.

There is not a rose colored price outlook, but doldrums appear to have been avoided.

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