Plexus: Don’t Read Too Much Into Cotton Market Gains
September 4, 2012 NY futures went nowhere this week, as December edged up just 14 points to close at 76.94 cents.
After dropping to a low of 74.72 cents on August 24, the market has been able to climb back to the 77 cents level. However, we should not read too much into this week’s action, since trading volume has been light between 9,000 and 14,000 contracts and open interest has barely changed since last Thursday. This tells us that there is currently no momentum in the market and that the positive price action we have seen over the last four sessions was probably due to a lack of selling rather than any strong buying, as potential sellers were hesitant to go short with Hurricane Isaac moving up the Delta and with soybeans posting all-time highs.
Hurricane Isaac made landfall as a category 1 storm on Tuesday night, bringing torrential rainfall to the southern Delta. From a cotton perspective Louisiana is probably the state that was most affected by the high winds and heavy rain, while we don’t expect to see too much damage in Mississippi and Arkansas. The overall impact from this storm on the US cotton crop should be minimal, because Louisiana only produces around 400,000 bales or just over 2 percent of total output. However, this hurricane serves a reminder that the crop is still vulnerable to adverse weather and we therefore don’t expect trade selling to intensify until harvest is well under way.
Business has remained relatively slow as mills seem to be in no hurry to buy more than what they absolutely need. US export sales for the week ending August 23 amounted to just 98’900 running bales of Upland and Pima for both marketing years, with shipments totaling 167,500 running bales. Total commitments for the season are now at 4.7 million statistical bales, of which just 0.5 million bales have so far been exported. Compared to last season, sales are running about 2.3 million bales behind at this point. As we have pointed out before, the fate of US exports depends to a large degree on China’s willingness to import sizeable amounts of cotton this season, despite its large stockpiles.
So far commitments to China amount to some 1.7 million statistical bales, just slightly less than the 1.9 million bales we had on the books a year ago. However, the odds for China to release additional import quotas for the rest of the calendar year are not great. China seems to be willing to auction off 300’000 tons of its strategic reserve at a price of 18,500 yuan/ton, or around 133 cents/lb. This cotton apparently consists of Xinjiang 2011/12 crop, which the Reserve bought at a support price of 19,000 yuan/ton last season. Although the amount to be sold is not huge at 1.38 million statistical bales, it marks a significant departure from the past, because it is the first time that reserve stocks are being released at a loss.
We believe that China’s cotton policy will be the most important price factor this season and it still anybody’s guess how that’s going to play out. China faces a big dilemma, because not only has it accumulated over 4 million tons in reserves stocks, consisting of both domestic and imported cotton, but it continues its support purchases this season, at a price level that is significantly above the local and international market at 20,400 yuan/ton.
While this support price greatly benefits farmers, it is detrimental to textile companies that export their products. Last season China solved the problem by letting cheap imports of cotton and yarn in, but this approach has its limits for obvious reasons. The decision to let reserve stocks go at a loss may signal a policy shift for the current season, a change that is potentially bearish for international prices. China has an estimated production deficit of just 8 million bales this season and if this shortfall is at least partially filled with reserve stocks rather than imports, it would leave a lot of cotton looking for a home, particularly in the US.
While we see near term fundamentals as bearish, the market continues to find support from strong grain and soybean prices as well as speculative buying. Money managers continue to like the commodity complex and have increased their long positions in futures and options to their highest level in 15 months. Since early June the GSCI spot index, which measures 24 commodities, has rallied by over 20 percent, partly because of the drought and partly because of the Fed’s easy money policy, which gives money managers the confidence to approach asset markets from the long side. However, since the economy is still without a proper growth engine, it depends on further stimulus to keep it going. Traders will therefore be all ears to hear what Mr. Bernanke has to say during the upcoming meeting of central bankers at Jackson Hole, Wyoming. If the Fed fails to meet the high expectations of the market in regards to further money printing, we could see some profit taking across commodity markets.
So where do we go from here? The market is drifting sideways, waiting for something to generate momentum. Since the cash market remains tight until new crop supplies start moving in, there is no crop pressure just yet, which has allowed outside influences to act in support of prices. However, we still feel that the market will trend lower once harvest pressure sets in. Since the board offers just a little over 2 cents of carry for the Dec/July spread and since China is likely going to be less active on the import front than last season, there should be plenty of cotton looking for a home in the not to distant future. Only once this new supply has been reduced to a manageable level and new crop plantings start entering the discussion, may we finally see a long-lasting price recovery.
THE FOLLOWING IS AN OPINION, AND SHOULD BE TAKEN AS SUCH. PLEXUS CANNOT ACCEPT ANY RESPONSIBILITY FOR ITS ACCURACY OR OTHERWISE
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