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Trying to Read the Market: Bearish, Neutral or Bullish?

After finding the USDA October supply demand report initially bearish, cotton prices rebounded on the idea of stronger demand and significant questions with respect to the size of both the U.S. and foreign crops.

Indian prices were very strong, and seller offering was scant. Once that realization soaked in, the market was left with little to do other than ease higher.

As discussed in prior weeks, improved demand has been expected, and the U.S. crop was thought to be lower, as was the case. However, the world crop level was essentially unchanged, with world carryover marginally lower. Thus, a seemingly neutral report was taken by the market as mildly bullish.

This sets the stage for another test of the upper end of the five-cent trading range between 65 and 70 cents. That range will likely hold, but a wider 64-72 cent range cannot be discounted. More importantly, the market has seen little price volatility since prior to the September report. Therefore, the reality of a 21 million bale U.S. crop has not pressured New York futures.

The “surprise” in the October report was that USDA was still unable to make any changes in production estimates for the Upper Coastal Bend region of Texas. Analysts initially indicated that 300,000 to 500,000 bales were lost due to Hurricane Harvey. The typical layman had assumed the area was back to normal, but nothing is further from the truth. The combination of long term flooding in fields, destruction of ginning and other infrastructure, and the growers inability to respond to USDA surveys required that USDA essentially leave prior estimates unchanged.

An internal debate within USDA is underway as to how to accurately report the actual crop production, as well as how to account for production that was lost to the storm (USDA protocol requires it be counted as production even though it never entered the marketing chain). Thus, the actual effect of Hurricane Harvey likely awaits either the December or the January crop production report. Regardless, it is still expected that the impact, or specifically the loss in production, will be near 500,000 bales.

Of course, by then the U.S. will be well past peak harvest, and the weather effects of the High Plains and Rolling Plains crops could dwarf any hurricane impact. The U.S. crop was estimated at 21.1 million bales, down from the September estimate of 21.8 million. My estimate proved to be far too low, as I had expected the impact of Hurricane Harvey to be included.

Essentially, the reduction in crop size was divided equally between Texas and Georgia, the two largest producing states. Each was down about 300,000 bales from the September report. Texas production was estimated at 9 million bales, compared to 8.1 million in 2016. The Georgia crop was estimated at 2.4 million bales, versus 2.2 million in 2016.

Due to the smaller U.S. crop, USDA reduced its export estimate 400,000 bales, from 14.9 to 14.5 million bales. Domestic consumption was left unchanged at only 3.35 million bales, and the resulting carryover was lowered 200,000 bales, down to 5.8 million. It is expected that carryover will slide further as production estimates become more stabilized. Nevertheless, due to a sharp increase in the production of low grades in 2017, carryover will continue to be burdensome.

World cotton production was increased 100,000 bales over the September estimate, up to 120.9 million. Offsetting the loss in U.S. production were increases in Brazil (300,000 bales) and slight increases in the EU, Mexico and the Southern Hemisphere. However, world consumption was increased 250,000 bales, principally in Vietnam and a slight increase in Turkey. An expected increase in China did not materialize and still awaits the USDA stamp of approval.

The decline in U.S. exports, principally due to quality loss, was offset by increases in exports for Brazil, Australia and India. That is, countries that have the high quality cotton will be able to meet the quality requirements due to a shortage in U.S. high qualities.

USDA increased world exports some 450,000 bales, a reflection of stronger demand, and lowered world carryover marginally about 150,000 bales, down to 92.4 million bales. This represents about a 3 million bale increase above beginning stocks.

The long standing analysts’ debate with USDA regarding Indian carryover remains unsolved, and it is noted that Indian Shankar was 78 cents at week’s end. The point is that if India had carryover as large as estimated by USDA, then Indian merchants – as a group possibly the most astute in the world – would empty their warehouses. Too, as a group, most, if not all, world analysts have now openly challenged the USDA carryover estimate for India.

That being said, the USDA database is the best. Too, it is generally believed that New York is trading a much lower carryover than projected by USDA. This is reflected in local Indian prices, the lack of aggressive offering by Indian merchants and the penchant for New York to seemingly refuse to move lower in light of seemingly bearish reports. The market is all but advertising that we are misreading its intentions.

A bearish report that cannot move the market lower is telling us that it may not be bearish. Rather, it’s likely implying that the market is in equilibrium heading into 2018.

Expect the long standing 65 -70 cent trading range to continue, with the possibility of slight bleeding on either end.

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