Plexus: December Cotton Holding Steady As U.S. Exports Soar

New York futures had a mixed performance in the past week, as December fell 173 points to close at 74.79 cents, while March advanced 89 points to close at 78.35 cents.

The December/March spread remained at the center of attention, with the difference widening dramatically to nearly 400 points, after the two months traded at par just a little over a week ago. We believe that December has now become very attractive to potential takers as an outright purchase at 75 cents or on a spread at full carry. Considering the stiff basis some prominent merchants have been willing to pay for cash cotton this week, we have to assume that a large portion of the current Certified Stock (264,000 bales including bales under review) is going to disappear over the coming weeks.

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There was a flurry of excitement last Wednesday. The market shot up 200 points based on two news items out of China, with March trading as high as 79.45 cents.

First, it was reported that China’s CNCRC expected the crop to be at just 6.68 million tons or 30.7 million statistical bales – quite a bit lower than the current USDA estimate of 32.5 million bales. The second story referred to rumors about the Reserve delaying auction sales by several weeks. This caught some local traders with short positions by surprise and led to a sharp rally in the Zhengzhou futures market, which spilled over to the New York futures market during the overnight session.

ZCE futures are currently in a steep inversion, with the January contract trading about eight cents per pound above the May contract. Prices on the CNCE are showing a similar inversion. However, we need to remember that this is an artificial squeeze, since China has more than enough cotton with its massive stockpile. In this context, the fact that China’s crop may be slightly lower than expected this season is insignificant.

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Many global markets are currently seeing a nearby shortage of cash cotton, as the market is still refilling a nearly empty supply pipeline. Some traders may have overcommitted for nearby shipments and are finding it difficult to find coverage. The U.S. is no exception. Merchants have been scrambling to get their hands on cotton, since the crop has been later than usual, and logistics can only handle so much with load out dates at warehouses backed up until January in many cases.

Meanwhile, U.S. export commitments keep rising at a torrid pace, with around 1.8 million bales sold over the last six weeks. U.S. export sales for the week ending November 14 amounted to a stellar 331,300 running bales net, with Turkey (117,600 bales) and China (68,100 bales) leading a group of 22 different markets. Total commitments for the season now stand at 6.3 million statistical bales, of which 2.1 million bales have so far been shipped.

Including the 3.6 million bales that domestic mills consume this season, the U.S. has already committed 9.9 million bales – or 73 percent of this year’s estimated domestic crop – by the middle of November, with eight and a half months to go in the marketing year.

With just 3.7 million bales to go before this year’s crop is committed, the U.S. doesn’t need to be in any great hurry to put additional sales on the books. Rather than making itself more attractive to buyers, the U.S. will probably have to start rationing its remaining supply. This may happen via a weakening basis of non-U.S. growths, as other origins are not nearly as well sold and may have to lower prices in order to capture business. U.S. prices should stay comparatively firm.

The latest CFTC report showed a large reduction in overall open interest in the wake of December options expiration. Open interest for futures and options positions combined dropped to 211,295 contracts between November 5 and November 12, as specs and trade both cut their outright long and short positions, but with little change in their respective net exposure. Speculators large and small extended their net short slightly from 0.5 to 0.8 million bales, while the trade’s net short remained unchanged at 5.6 million bales. On the other side of the ledger, Index traders increased their net long position from 6.0 to 6.4 million bales.

The fact that specs and the trade are both net short is another reason not to get too bearish on U.S. futures right now. With low prices and the advanced stage of U.S. export sales, it is unlikely that either group will pile on additional shorts at this point. Index Funds, who are the lone group on the long side, are not likely to alter their position by much, although they may become light sellers in early January due to the annual rebalancing.

So where do we go from here? We feel that New York futures are currently cheap enough with December at 75 cents. The question is whether March will follow in December’s footsteps as many traders expect, or whether it will be able to muster some strength of its own.

A lot will depend on what happens with the Certified Stock. If a sizeable amount of it disappears over the coming weeks as anticipated, then March will have to “buy” its own Certified Stock and would have to move higher in order to attract cotton away from a highly contested cash market. In the near term, we could see March move to the upper end of what we still see as a broader 75-to-82 cent range.

Only when the nearby supply constraints are behind us do we see the potential for additional price pressure in the U.S. market. Given the high level of commitments this early in the season, we expect the December lows to hold.

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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