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Market Underpriced, as USDA Drops Production Estimates

The much-awaited October supply demand report was released with much enlightenment, but with few surprises. Estimates for the U.S. crop were well expected generally, as were those for the world situation.

Yet, as is far too common, USDA made historical adjustments which were impossible to gauge, but I both respect and appreciate their persistent efforts to get it right so to speak. I am one of the first to be flagged for piling on them. But I also know they are a major and highly respected part of the market news and analysis service, and their mission is paramount to the world cotton industry – but more so to the U.S. cotton grower.

The U.S crop was lowered 100,000 bales, down to 13.2 million. Look for at least another 100,000 bale reduction as the season progresses, possibly as much as 200,000 by year end. Exports were unchanged at 10.2 million bales. Domestic consumption was unchanged, and carryover stocks were estimated to be 100,000 bales lower – down to 3.1 million due to the reduction in crop size.

This estimate for ending stocks represent 22 percent of the annual total use and sets the stage for a price rally later in the year. Ending stocks may well be down to 2.8-2.9 million bales by the end of the 2015-2016 marketing year (July 31, 2016).

The world cotton situation was summarized by a reduction in both production and consumption, but also an increase in world carryover. There is still a little black magic everywhere in the cotton industry, but nothing to hide by USDA. World production was reduced by 1.4 million bales, down to 107 million, and world consumption was reduced 1.2 million bales. However, USDA did increase world beginning stocks by 900,000 bales (China). Thus, world carryover was increased 700,000 bales up to 107 million.

Major changes came from the revised estimates in Chinese production (down 700,000 bales to 25.3 million), a 500,000 bale reduction in the Pakistani crop (down to 9.5 million). The Brazilian crop was lowered 200,000 bales (down to 6.5 million) and the Australian crop was lowered 100,000 bales (down to 2.1 million bales). African Franc Zone production (Mali) was increased 430,000 bales.

These estimates are very solid in my opinion, and I applaud USDA for making major adjustments in both the Chinese and Pakistani crop this early in the production season. Yet, let’s not be too complementary. I remain of the opinion that USDA has the Indian crop at least one million bales too high, and possibly has it overestimated by two million bales. Thus, year-ending world stocks are still some three to five million bales overestimated.

Regardless, one can still claim the 2015-16 year ending world stocks will still be north of 100 million bales, and that is just too much cotton to allow for a significant price rally.

However, maybe not! Dig into the numbers a bit further.

U.S. ending stocks are estimated at 3.1 million bales and headed to 2.9. Australian ending stocks are lower, down to 1.4 million bales. Brazilian stocks are down to 6.9 million bales and will likely fall by at least another 100,000. Ending stocks of the much demanded U.S., Brazilian and Australian stocks were down 400,000 on this month’s estimates alone. Expectations are that the combined reduction will be 800,000 bales by year’s end.

High quality cotton just became more expensive.

Granted, the New York ICE contract is a 41-4-34 market. The world is a 31-3-35 market. The quality cotton market is a 31-3-36 market. Real price differences are paid by mills seeking high quality and staple lengths 38, 39, 40 and 41. The USDA CCC loan schedule does not even have those grade/staple length values in its data base. Thus (I stand to be corrected), the USDA CCC loan schedule calculation does cause true market prices to be hidden from all market participants, making it more difficult (or impossible) for the grower to get his fair share of the enhanced price premium paid by mills. Consequently, it is even more unlikely that the spot market differentials would be reflected, even though differences actually exist.

(The loan schedule does not reflect premiums for today’s long staple Upland cotton. Additionally, spot market price reporting is handcuffed and highly restricted by the nature of the changing cotton industry. These restrictions challenge the issue of observing the true price differentials of actual cotton trading. The collection and in-house calculation of price information reported to and collected by USDA is not under challenge, and neither should it be.)

The market received a psychological boost this week from the weekly export sales report. Current market year sales were 206,900 RB of Upland and 3,000 RB of Pima. Mexico, Vietnam and Turkey were the major buyers.

This was a very respectable weekly sales level. However, the real boost came from the purchase for 2016-17 delivery of 358,300 RB to Mexico. This represents about 20% of the estimated total annual consumption by Mexican mills. Too, the idea of booking such a large portion of needs at one time – and for as much as nine to 21 months out – suggests someone other than myself is thinking of higher cotton prices.

Cotton remains well underpriced.

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