Plexus: New York Futures Face Renewed Pressure

Friday’s USDA report was the latest in a series of bearish supply/demand estimates that saw global ending stocks rise by nearly 13 million bales since the initial 2011/12 projections were released last May. Back then the USDA estimated endings stocks to amount to just 47.93 million bales at the end of this season, while it is currently carrying a number of 60.77 million bales. 

 

The 2.4 million bales jump in ending stocks this month was primarily the result of a 1.45 million bales upward revision in Indian beginning stocks and a 0.4 million increase in Pakistan’s crop. This marks the first time since the 2008/09-season that global ending stocks are back at over 60 million bales. Between 2004/05 and 2008/09, world stocks were consistently high at somewhere between 60.6 and 62.5 million bales, before they fell to just 45.3 million bales in 2009/10, setting the stage for the historic bull market that followed. However, with ending stocks once again plentiful, especially when compared to the current level of consumption, it is difficult to argue a bullish case at the moment.

 

Interestingly, USDA’s numbers are comparable to those of the 2004/05 season, when world production amounted to 121.5 million bales, mill use was at 109.1 million bales and ending stocks were at 60.6 million bales. However, the major difference to seven years ago is that spot futures traded in a range between 42.10 and 60.50 cents during the 2004/05-season, far below the current price level. Does that suggest that cotton prices are way too high? Not necessarily, because we cannot look at the cotton market in isolation. 

 

Seven years ago corn prices were a third of what they are today and soybeans were less than half as expensive. Since these two crops are cotton’s main competitors for acreage, cotton has to defend its ground by maintaining a certain price ratio to corn and soybeans. Then there is the cost of energy, as measured mainly by the price of crude oil, which has more than doubled since the 2004/05-season, making crops more expensive to produce. Ditto for the cost of labor in many countries. Last but not least there is the purchasing power of the US dollar, which has declined substantially over the past few years due to the reckless money printing by the Fed. The Fed’s balance sheet has nearly quadrupled since then and the gross national debt is more than double of what it was seven years ago. As a result we have see then price of gold go from about $400 dollars to $1730 dollars an ounce. In other words, while prices of tangible assets, such as commodities, have risen in nominal terms, their real value has actually declined.

 

Therefore, while cotton may seem expensive based on the statistical comparison to 2004/05, the above-mentioned factors make it unlikely that cotton prices will drop to the level of seven years ago anytime soon. However, this is not to say that values couldn’t come under pressure in the months ahead as the market shifts its focus to new crop plantings. In order to prevent ending stocks from growing to a record level next season – the current record being 62.5 million bales set in 2006/07 – we need to see a rather pronounced drop in production and a simultaneous increase in mill use in order to erase or at least substantially reduce the 13.6 million bales production surplus we had this season. The market cannot afford to have another surplus like that in the coming season, otherwise the resulting increase in ending stocks would depress prices.

 

Early indications are that world production will decline next season, notably in China, where plantings are expected to be 10% less. Other areas may see some cutbacks as well, but it is still too early to get a good grip on acreage. Tomorrow the National Cotton Council will provide us with its report on US planting intentions, which should come in slightly lower than last year. 

 

Consumption is too low at 109.7 million bales and should rebound over the coming season, especially if cotton prices were to remain relatively low. However, at this point it is doubtful that consumption will increase fast enough to close the gap to production and we may therefore see ending stocks continue to increase slightly in 2012/13.

 

So where do we go from here? Even though physical business has been quite active for nearby shipment over the past few weeks, which is supportive, the market is starting to look more and more towards the coming season. At this point the statistical picture is shaping up to be slightly bearish, although it is still early in the game and planting decisions have not yet been finalized. Weather will play a major role in all this as well, and based on what we have seen in recent months, it should keep things interesting. Also, as we have pointed out above, the price of cotton is linked to a number of other factors, such as the performance of competing crops for example. As long as corn and soybeans are able to hold their current levels, it will be difficult for cotton to move too far in the other direction. 

 

Short-term price action has turned negative and the market may want to retest the 84.00 cents support level over the coming weeks. However, over the medium-term we continue to see the market in the broader sideways trend it has been in since last July.