The market has remained undecided as to where it wants to go next, with the last eleven sessions closing in a narrow range of just 166 points. The structure is still more or less the same in current crop futures, with specs and index funds owning an equal amount of net longs, while the trade still seems to be firmly committed to the short side.
In fact, both sides have continued to add to their respective positions according to the latest CFTC report, with spec net longs (including non-reportable positions) up 1.3 to 6.1 million bales, index funds up 0.2 to 5.9 million bales and trade shorts up 1.5 to 12.0 million bales.
Outright trade shorts are actually quite a bit higher at 15.1 million bales, although some of that is obviously tied to new crop hedging. Nevertheless, we estimate that outright trade shorts in May and July still amount to some 11.0-11.5 million bales, which is an impressive number considering how little current crop cotton remains available.
Mills have made only some small progress in getting their unfixed on-call sales reduced last week, as they still amounted to 4.61 million for May and July combined. There were about 0.33 million bales added for December and later contract months, which brings total unfixed on-call sales to 6.71 million bales.
US export sales were surprisingly strong considering that prices traded 3-4 cents higher than the week before. Commitments for the current marketing year rose by 54’800 running bales net, while sales for August onwards increased by 135’900 running bales. Judging by the countries that booked these ‘next marketing year’ commitments, we have to assume that most of that cotton will be shipped from existing stocks during the August/October period.
Shipments were once again stellar at 345’000 running bales, and for those who are still concerned about Chinese cancellations, we would like to reiterate that outstanding sales to China amount to less than 400’000 bales.
While the market still has the potential to move higher on a short squeeze, we are getting increasingly nervous about the soon to be released government support and Reserve policy in China. Although most traders feel that China won’t make any drastic changes and instead may aim to reduce its stockpile in a slow and orderly fashion over the course of several seasons, even such a measured approach will probably have a negative impact on prices going forward.
Over the last three seasons production in the ROW (rest of the world) has outpaced mill use in the ROW by a combined 56.2 million bales. Thankfully China has been willing to absorb nearly the entire ROW surplus by importing 55.9 million bales during that time frame.
Since China’s own production gap amounted to just 8.5 million bales over these three seasons, it saw its stocks grow from 10.6 to 57.8 million bales since 2010/11. Additionally, China has supported ROW mill use by moving some of its factories outside its borders and by boosting yarn imports, mainly from India, Pakistan and Vietnam, to nearly 10 million bales per annum.
Unfortunately we believe that the ROW won’t be able to count on China’s support for much longer. Let’s assume that China’s production next season were to drop by around 15% or some 5 million bales to just 27 million bales and that mill use were to remain at the current 35.5 million bales. This would result in a seasonal production gap of 8.5 million bales.
Therefore, in order to neither increase nor decrease its stockpile, China could import no more than 8.5 million bales. Since early projections point to a ROW production surplus of around 13 million bales, ROW ending stocks would therefore grow by 4.5 million bales to 43.4 million bales under this scenario. By comparison, over the last 10 seasons ROW ending stocks ranged from 32.8 to 42.2 million bales.
The above scenario is based on a ‘status quo’ approach, assuming that Chinese stocks would remain unchanged. However, since China will most likely want to see its stockpile decline over the coming years, this can only be achieved by a) lowering production even further, b) boosting mill use, c) lowering imports or d) a combination of the above.
While lowering production would be the most desirable option from a ROW point of view, we doubt that China’s output is going to fall precipitously next season. In order to increase mill use, China would probably have to curb yarn imports and force local prices a lot lower, both of which would not be friendly for ROW prices. But most negative from a ROW point of view would be a drastic drop in imports, possibly to no more than the mandatory Tariff Rate Quota (TRQ) of around 4.1 million bales.
So where do we go from here? While May and July have the potential to act like loose cannons over the next couple of months, the longer-term view doesn’t look quite as supportive in our opinion. Some of this sea change coming out of China may already be discounted by the market, hence the big inversion between July and December, but if China ultimately decides to lower its stockpile and if ROW production meets current expectations, new crop prices may struggle to keep their current value.
