After trading to a low of 82.11 cents last week, downside momentum faded and the market was able to move slightly higher this week, with December closing today about 300 points above important long-term support at 81.72 cents.
The lack of momentum was evident from the low trading volume, which averaged just around 14’000 contracts per session between Friday and Wednesday, before picking up slightly to an estimated 17’371 lots today.
The much anticipated USDA report contained no great surprises, as world production was increased by about a million bales to 117.4 million bales due to the bumper crop in India, while global mill use was reduced by 0.3 million to 109.5 million bales. Even though global ending stocks increased by nearly a million bales to 94.7 million bales, the market failed to react negatively to the report.
As we have learned over the last couple of seasons, what drives prices is not so much the total quantity of stocks, but rather where these stocks are located and whether and at what price they are available.
From that point of view the latest USDA report is perfectly balanced, because the ROW (rest of the world) is expected to produce a seasonal surplus of 10.9 million bales, which Chinese imports of 11.0 million bales are supposed to absorb. In other words, ROW inventories are expected to stay at a relatively tight level of 36.4 million bales. For comparison, over the past ten seasons ROW stocks have averaged between 32.5 and 42.0 million bales.
However, these ROW stocks could get a lot tighter if China were to import more cotton than expected. Over the last two seasons most analysts have significantly underestimated Chinese imports! For example, a year ago the USDA estimated in its September report that China would import 12.0 million bales, but they ended up taking 20.3 million bales.
Same story two seasons ago, when China was expected to import 14.5 million bales and the final number was 24.5 million bales. What if Chinese imports were to beat expectations again this season?
Remember, China needs to take only 10.9 million bales to wipe out the ROW production surplus, which is not much compared to what they have imported over the last two seasons. Since China hasn’t made any changes to its cotton policy yet and in fact has started its procurement program this week, paying 20’400 yuan/ton or 150.00 cents/lb for domestic cotton, the incentive to import more affordable cotton and yarn is certainly there.
China can control imports to some degree via quotas, but once the yearly TRQ (Tariff Rate Quota) and the contractual 3-to-1 quota allocations have been filled, it doesn’t really take that much more before China starts digging into ROW stocks.
In that regard we need to keep an eye on imports that may be done at the full 40% tariff, for which no quota is required. Last year Chinese mills and traders imported an estimated 900’000 tons (4.1 million bales) under that scheme and if world prices were to drop by some five cents from current levels, we would likely uncover an open-ended bid from Chinese buyers. Sooner or later China will have to make some changes to its current policy in order to prevent any further build-up of stocks, but for now it is still business as usual!
While spec long liquidation has started to subside after nearly half of the net long got flushed out in a matter of just two weeks, dropping from 9.0 to 4.8 million bales net long, trade buying has emerged in support of the market.
The more attractive price level prompted mills to book 387’600 running bales of US Upland and Pima cotton over the last two weeks, with China taking the lion’s share at over 160’000 bales. For the season total commitments now amount to 4.0 million statistical bales, whereof 1.1 million bales have so far been shipped.
Considering that US exports are estimated at only 10.4 million bales this season, the US shouldn’t have too much trouble achieving this target despite competition from cheaper origins like India or West Africa. What may happen is that the US gets pushed into the role of residual supplier, but as long as China imports 10 million bales or more, all of this US cotton will eventually be needed.
So where do we go from here? With the exception of a failed breakout attempt to the upside, which lasted all of seven sessions, the December contract has been stuck in a sideways range between 82 and 89 cents since early February.
After holding support last week, the market is now trending back towards the middle of this range, although it is lacking momentum. As we have explained earlier in this report, the statistical picture currently support the status quo and it will take a significant event to get the market out of its comfort zone.
Adverse harvest weather, a change in China’s cotton policy or geo-political/macroeconomic events are such potential catalysts, although at the moment there is nothing on the horizon just yet. We therefore expect the market to continue to move sideways in the foreseeable future, supported by a strong Chinese bid below 80 cents and overhead resistance stemming from cheaper competing growths.
