Plexus: U.S. Exports Give Futures Market a Shot in the Arm

 

NY futures came under renewed pressure this week, as May dropped 222 points to close at 87.34 cents, while December fell 302 points to close at 88.27 cents. 

 

The market was on the defensive for most of the week after India had lifted its export ban, but a stellar US export sales report gave it a much-needed shot in the arm this morning. These strong US sales were probably a direct result of the uncertainty surrounding the Indian export situation, as buyers turned to the US for nearby coverage. 

 

For the week ending March 8, US export sales of Upland and Pima cotton totaled 247’800 running bales net for the current marketing year and an additional 118’800 running bales for next season. It was encouraging to see that a total of 18 markets participated in the buying. Shipments continued at a fast pace, as 379’200 running bales left the country last week. For the season, total commitments now amount to 11.7 million statistical bales, whereof 6.1 million have so far been exported. These numbers do not include an additional 1.5 million bales in “optional origin” sales. 

 

The cotton market has been feeling rather heavy lately, as values fell to their lowest level since Christmas this week. At the root of this depressed mood is a bearish statistical picture, which predicts global ending stocks to rise to their highest level ever at the end of the 2012/13-season, due to three consecutive years of overproduction. However, the situation is not as simple as the statistics may suggest, because the dynamics are quite different for current and new crop.

 

Let’s first have a look at current crop! Even though it is true that we have a large overproduction this season – 14.9 million bales according to the USDA – we need to remember that a) we started the season with relatively low beginning stocks and b) that a large percentage of this excess production is being absorbed into the Chinese Strategic Reserve. 

 

China has an estimated production deficit of 10 million bales this season (33.5 production less 43.5 mill use), yet it will import 18.5 million bales according to the USDA. In other words, China is taking 8.5 million bales more than it needs and these bales are going to be locked away for now. This reduces the burden of the 14.9 million bales seasonal surplus by 8.5 million bales, leaving an excess of just 6.4 million bales.

 

Considering that we started the season with relatively low beginning stocks, the 6.4 million bales aren’t really that much of a burden, since they were necessary to alleviate an otherwise tight stock situation. Further we need to consider that there are huge price differences between the various origins that hold these excess supplies. Take Central Asian and Australian cotton for example, which is priced considerably above other origins like Brazil, India, African growths, and even the US. If we take the exportable surplus of Central Asia and Australia out of the equation, there is actually more demand than supply for all the remaining, more attractively priced growths, and some of these origins are already well committed at this point. We therefore don’t expect to see much price pressure from the two largest exporters, the US and India, for the remainder of the season. Once all the cheap cotton has been bought up, mills will have to deal with higher priced origins like Australia and Central Asia (Uzbekistan and Turkmenistan). Although it is likely that these more expensive growths will eventually have to be discounted as well in order to book sales, this will probably occur via a weaker basis.

 

New crop shapes up to be an entirely different story! Not only are we looking at yet another seasonal surplus of perhaps 5 or 6 million bales, but China will probably not be there as a buyer of last resort, at least not to the same extent as this year. We may therefore see a lot more pressure on prices from origins all around the globe in the coming season. Take the US for example, which is looking at a potential crop of 17.5 – 18.0 million bales, but has only sold about 0.7 million bales at this point. Therefore, if another large world crop were to materialize and demand doesn’t recover beyond current expectations, we could see December futures trade down to 75-80 cents by harvest. 

 

There are several reasons why the market is not quite ready to discount such a dismal scenario: 1) The crop is not yet planted and intentions could still change, especially since soybeans and corn have been rallying lately. 2) Even if the crop were to get planted as intended, there is a lot of weather to negotiate and patterns have been rather erratic lately. 3) The continuous money printing by central banks is creating a tide that will eventually lift all the boats, be it the stock market, real estate or commodities. It is therefore dangerous to get too bearish on anything that has a dollar sign in front of it. 

 

So where do we go from here? There is no doubt that the path of least resistance is currently down. However, since US current crop is well committed, we are hesitant to short May and July and prefer to do short hedges in the December contract instead. If the market doesn’t build carry between July and December, we would expect any remaining old crop stocks to be aggressively offered, as no one wants to hold on to cotton going into a bearish new crop situation. This in turn should put pressure on the basis of these various origins over the coming months.