Plexus Weekly Cotton Report Offers a Mixed Bag
June 10, 2011 Plexus Cotton Limited
New York cotton futures ended the week sharply lower, as July gave back 1319 points to close at 151.05 cents, while December lost 624 points to close at 132.99 cents.
The USDA supply/demand report and the U.S. export sales report contained something for everyone. The bears were quick to point to the large sales cancellations, higher beginning stocks and reduced demand in China and India, while the bulls were focusing mainly on the declining U.S. crop.
The USDA has lowered both production and mill use in its latest report. World output is now estimated at 123.77 million bales, down from 124.72 million bales last month, which was mainly due to a reduction of the U.S. crop by 1.0 million bales to 17.0 million bales. However, if realized it would still be the largest crop the world has ever grown and about 9.5 million bales more than what was harvested in the current season. Global mill use is pegged at 118.95 million bales for 2011/12, which is 0.55 million bales less than last month, but still 3.44 million bales more than this season. Thanks to the first production surplus in six seasons, global ending stocks are expected to rebound by about 5 million bales, from 43.25 to 48.25 million bales.
The foreign production gap (production compared to consumption outside the U.S.) is currently estimated at just 8.4 million bales in the 2011/12-season, the second lowest in the last ten years. Last season the foreign production gap reached a record 25.7 million bales, while in the current season it is estimated at 15.2 million bales. This trend towards smaller production deficits means that there is less urgency to go after U.S. cotton, the world’s residual supplier. In fact, one could argue that since the U.S. has already sold 5.8 million bales to the rest of the world for next season, the statistical gap that remains to be bridged is relatively insignificant.
When we look at the current balance sheet for U.S. cotton, we had total supply at 21.0 million bales this season (2.9 beginning stocks + 18.1 crop), of which 15.6 million have so far been committed overseas and 3.8 million go to domestic mills. We further have already 5.8 million in export sales on the books for August onwards and domestic mills require another 3.8 million bales next season, of which a big part has already been contracted. This leaves us with a current statistical deficit of 8.0 million bales, which will eventually be worked off once new crop arrives this fall.
However, an 8.0 million bale deficit is quite a hole to climb out of! Let’s not forget that a good chunk of these commitments, both export and domestic, is owed for shipment in the August to October time frame, or before new crop arrives. Therefore, the case can easily be made that the U.S. is overcommitted for shipments until October/November and that some of these cancellations we have been seeing lately were actually necessary. In other words, we doubt that there would have been enough U.S. cotton to meet every commitment on the books and more cancellations may be needed over the coming months to balance out supply and demand.
Let’s do the math! Again, we started the season with a supply of 21.0 million statistical bales, of which 13.1 million statistical bales have already been exported until June 2nd and domestic mills have used up around 3.2 million bales so far. This leaves around 4.7 million statistical bales in existence at the beginning of June. From this number we first need to subtract what domestic mills use from June to October, which are roughly 1.6 million bales. This leaves the remaining 3.1 million bales for export, against which there are currently 8.3 million bales in export commitments on the books (2.5 million outstanding for this season and 5.8 million for August onwards). Even if the US were to ship just 200’000 bales a week from now on, warehouses would be empty in less than 16 weeks, or around September 20.
So where do we go from here? Some analysts seem to be worried that “excess” cotton from cancellations may be tendered on the July contract. Based on the above numbers they should be worried about the opposite! Unless July shorts are able to back up their bets with cotton, they could find themselves in a lot of trouble, because merchants may once again use the board to source cotton. Open interest in July was still at over 49,000 contracts as of this morning, although we need to see who is left standing after the Goldman roll and options expiration are behind us. There were still 1.7 million bales in unfixed on-call sales as of last Friday, which are way too many for our taste. The time for these shorts to get out is now, while there is still plenty of liquidity thanks to the Goldman roll. The longer they wait, the more they will be susceptible to a squeeze in a thin market.
Once July goes off the board, things will likely slow down quite a bit in the U.S. There are already plenty of forward sales on the books compared to the size of crop we are expecting, which means that export activity will come to a near standstill until new crop has arrived. Selling pressure on December should be light, both because of crop uncertainty and because there is not much cotton to hedge over the coming months. Traders in foreign growths may use the futures market for basis purposes, but they need to be careful not to get caught in a runaway market in case the crop deteriorates further. Being long foreign growths and short US futures may turn out to be a dangerous proposition this season.
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