Plexus: Cotton Market More Like Casino than Hedging Vehicle
July 2, 2012 Plexus Cotton Market Report
We can’t wait for the July contract to finally leave the board, because over the last couple of weeks it reminded us more of a casino than a legitimate hedging vehicle. When we look at this morning’s US export sales report, which showed big cancellations in China after two weeks of huge increases, we get the impression that some clever operators may have used the July contract for a classical ‘pump and dump’ play, inflicting considerable pain on many unsuspecting market participants while enriching themselves in the process. We hope that we are wrong with our suspicion, but it wouldn’t hurt for regulators to take a closer look as to whether everyone’s story checks out in regards to these large Chinese sales and subsequent cancellations.
US export sales for the week ending June 21 showed a net reduction of 599’200 running bales for the current marketing year, as China cancelled 618’300 running bales, while commitments for the 2012/13 marketing year increased by 87’900 running bales. Rather than focusing on reported sales, especially when they involve China, it may make more sense to instead look at how many bales have actually been exported. So far this number amounts to 10.5 million statistical bales, with outstanding commitments currently reported at 2.4 million bales for the current marketing year and 2.5 million bales for shipment August onwards.
With July all but history, we now have a board that is once again reflecting carrying charges. Since early 2010 the spot month has for the most part traded at an inversion, reflecting a tight US balance sheet, but with US and global stocks projected to be plentiful next season, this is changing. When we look at the current US supply/demand situation, we started the season with 18.2 million bales of supply (2.6 million beginning stocks and 15.6 million crop), of which 3.5 million go to domestic mills this season and 10.5 million have so far been exported. This leaves around 4.2 million bales, to which we add a projected crop of around 18.0 million bales next season, giving us an estimated supply of around 22.2 million. Against that we have current export commitments of 4.9 million bales and next year’s domestic mill use of around 3.5 million bales, which leaves some 13.8 million bales available for sale.
This means that the US will have to sell another 10 million bales over the course of next season, possibly more if the crop turns out to be bigger than 18 million bales, which seems like a tall order. However, as we have tried to explain in one of our previous reports, since China continues to take advantage of these much cheaper global prices and keeps importing more than its seasonal shortfall, and the rest of the world has only a very small production surplus next season, we don’t foresee a lot of pressure on US prices. If the market continues to sag from here, growers will stick their cotton in the loan and wait for rallies before they are letting it go. Also, at current prices it is quite conceivable that demand will improve, as cotton will reclaim at least some of the volume it lost to man-made fibers during last year’s bull market.
However, the most supportive factor for cotton prices going forward is the fact that food prices keep rising. Corn, soybeans and wheat all had impressive rallies over the last couple of weeks as large parts of the US are in the grip of an extreme heat wave that is deteriorating crop conditions. Weekly crop ratings for corn declined to the lowest levels for this time of the year since 1988, when one of the most damaging droughts in US history crippled yields. December corn has exploded to the upside since June 15, going from a low of 5.07 dollar/bushel to currently 6.31 dollars/bushel. November soybeans rallied on the same weather concerns, as well as strong Chinese purchases, although in the case of soybeans the key growing phase is not until later in the summer, while the critical pollination period for corn is just around the corner. November soybeans closed at 14.03 dollars/bushel today, up from a low of 12.55 dollars/bushel on June 1. The story is similar for wheat, which too has rallied sharply over the past few weeks, going from a low of 6.49 dollars/bushel to a current price of 7.68 dollars/bushel.
Tomorrow’s USDA planted acreage report will give the market something to chew on and the consensus number is at around 12.7 million acres, which compares to last year’s planted acreage of 14.74 million acres. Although this year’s acreage is quite a bit smaller, fewer acres will be abandoned due to much improved conditions in West Texas, which should result in a larger crop overall.
So where do we go from here? The big story at the moment is the heat wave in the US, which is causing a rally in grains and soybeans. Despite its bearish balance sheet, cotton doesn’t exist in a vacuum and needs to concern itself with defending its territory going forward. Although it is too late to impact the acreage of Northern Hemisphere crops, with the exception of India perhaps, we need to remember that the market is a discounting mechanism that projects into the future. As long as competing crops (soybeans and corn) hold at current levels, we see it difficult for cotton to concede further ground. On the other hand there is still a lot of producer hedging to be done, which should cap any attempt to move beyond the mid-70s. We therefore continue to see the market in a trading range between 65 and 75 cents in the foreseeable future.
Ed: The above is an opinion, and should be taken as such.Plexus cannot accept responsibility for its accuracy or otherwise.
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