Ongoing planting delays continued to keep potential sellers at bay this week, which allowed the market to trend higher. West Texas is still too dry, while parts of the Mid-South and Southeast have experienced wet and unseasonably cool conditions.
Old Man Winter is apparently still not quite ready to quit, as another cold front is dipping down from Canada this weekend, bringing more rain to the Memphis territory, with low temperatures dropping into the high 40s. Fortunately the weather is finally expected to improve once this next front has passed.
While there is still time to get the seeds in the ground without losing yield potential, the US crop will be quite a bit later than normal and therefore becomes susceptible to adverse weather conditions in the fall. This means that traders and mills will rely more than usual on current crop supplies for their late summer shipments. The problem is that there is not really that much cotton available anymore in the US, after strong export sales have reduced inventories considerably in recent months.
Here is the math! We started with supplies of 20.65 million statistical bales, of which 13.1 million have so far been sold for export and 3.4 million go to domestic mills. This leaves theoretically 4.15 million bales for sale, but at least 1.0 million have to be reserved for domestic mill use from August to October/early November and a similar amount is needed for exports from August onwards.
Export commitment currently amount to around 1.6 million statistical bales for 2013/14 and we estimate that at least two-thirds of these bales are for shipment August/October. Therefore, after backing out these reserves, we are left with just around 2.2 million bales still available for sale, of which 0.5 million are in the certified stock!
Considering the low amount of unsold stocks in the US, and in most origins outside China for that matter, it is surprising that open interest in July futures keeps getting bigger. After all there are just a little more than six weeks left before July enters its notice period and there were still 118’886 contacts open as of this morning, 7’459 more than a week ago.
Maybe the shorts are hoping for the inversion to fade away or for the selling basis on their unsold physical positions to improve, but by waiting and increasing the position they are playing a dangerous game.
Tomorrow’s USDA supply/demand report, in which the government provides its first detailed look at the 2013/14-season, will give traders something to chew on and determine the market’s next move. Analysts seem to agree that world production will likely exceed mill use for a fourth season in a row. Although world production is expected to decline to around 114-115 million bales, mainly due to reductions in China and the US, it is probably not enough to drop to the level of consumption, which should improve slightly to around 109-110 million bales.
However, although the world may add another five million bales to ending stocks next season, it doesn’t automatically translate into a bearish market environment. As we have learned this season, we need to pay attention to what happens to the balance sheet in the rest-of-the word and how much China is going to import. For example, if the ROW were to produce a 7 million bales surplus, but China imported 10 million bales, then stocks in the ROW would drop by another 3 million bales, which would be supportive to prices!
So where do we go from here? From a technical point of view the market has held exactly where it needed to and July is currently about 4 cents above the long-term uptrend line dating back to November, which is running through around 84 cents/lb today. The strong rebound we have seen over the last couple of weeks has also drawn some spec buyers back in, as evidenced by the rising open interest in July, although they will be quick to pull the plug on any signs of weakness.
From a fundamental point of view a lot depends on how new crop progresses over the next 3-4 weeks. If the Mid-South and Southeast get their crop in and West Texas receives some rain, then prices should come under pressure, especially in December, as growers will want to hedge some of their new plantings. On the other hand, if the weather continues to be obstructive, we could see some nervous traders trying to get out of their July shorts.
After the nice run up to 88 cents we adopt a more neutral or even a slightly bearish stance at this point, since the futures market has once again gotten itself ahead of the physical market and plantings should make rapid progress starting next week.
