The market has felt deflated ever since the wild ride on March 26, during which the spot contract shot up to a high of 97.35 cents/lb before dropping more than 500 points below that level by the end of the session.
From a technical point of view there have been a number of developments alerting us to a trend change lately and the weakness on the chart is likely to take a few more spec longs out of the game in the weeks ahead.
The spot month has once again broken below the uptrend line dating back to late November. This is not the first time that has happened, as the market showed similar weakness in late February and eventually managed to resume its uptrend.
Nevertheless, this time around the breach looks more pronounced, since the market has been making lower highs and lower lows for a couple of weeks now. Further there are several momentum indicators - such as the RSI, MACD and Stochastic - confirming the weak trading action.
However, any spec long liquidation is likely to encounter strong trade support, as there are still 4.1 million bales in unfixed on-call sales on May and July, while merchants have plenty of basis-longs to sell. Last week’s CFTC report showed the trade still 12.1 million bales net short, most of which are tied to current crop futures.
This week the index fund roll has been providing a lot of liquidity for trade shorts to either get out entirely or to roll into July. Based on what open interest is telling us the majority of these shorts has opted for the latter. This harbours certain dangers, since liquidity will dry up considerably after the roll period and unless we see large-scale spec liquidation, these trade shorts may ultimately find it difficult to get out.
While May and July have been stalling, December traded to a new seven-month high today, thereby closing the July/Dec gap to just 945 points. This narrowing of the spread is a reflection of what we are witnessing in the cash market. Mills have been trying everything in their power to limit nearby purchases in order to benefit from cheaper new crop prices down the road.
While that puts pressure on current crop offers, it also leads to pent-up demand later this year, which should act in support of December. Chinese mills for example are much more likely to use their additional import quotas in the third and fourth quarter, when prices are more attractive.
China announced some details regarding its price support policy for the 2014/15-season, whereby growers in Xinjiang will receive a target price of 19’800 yuan/ton, consisting of the market price for cotton plus a ‘target deficiency payment’ by the government.
Details of this subsidy scheme are still pending, but it is believed that WTO rules limit the amount the government is allowed to spend under such a subsidy scheme to somewhere in the vicinity of 3’000 to 3’500 yuan/ton, based on an expected crop size of around 20 million bales in Xinjiang next season.
Assuming that Xinjiang cotton is going to be marketed somewhere between 16’000 to 16’500 yuan/ton next season – Chinese futures for January’15 delivery are currently trading at 16’100 yuan/ton – it would imply that import prices for high grade cotton cannot exceed 98-100 cents/lb C&F under the sliding scale duty scheme and a few cents more under the 1% TRQ. Calculating it back to a NY futures equivalent, we arrive at prices in the high 80s.
In other words, this new support policy is likely to lower the Chinese price ceiling considerably compared to previous years and it will also narrow the gap between Chinese and international prices, which could impact the competitiveness of cotton and yarn imports going forward.
Wednesday’s USDA report contained no major surprises, as the US crop was lowered to 12.9 million bales as expected, which means that US ending stock are now projected at just 2.5 million bales, the lowest in 23 years. Chinese imports increased by a million bales to 12.0 million bales, which leads to a further tightening of ROW ending stocks to 38.1 million bales. That’s nothing out of the ordinary though, since ROW stocks have fluctuated between 32.8 and 42.2 million bales over the last ten seasons.
US export sales of 109’600 running bales for both marketing years combined seemed to disappoint the market this morning. However, considering that there are only about 1.5 million bales left for sale according to our calculation, the light sales number may have more to do with limited supplies than with a lack of buyers.
There were again some cancellations, but most of them seemed to consist of rollovers to next marketing years. Shipments were once again excellent at 311’700 running bales and at this pace it would take only seven more weeks to get the remaining commitments exported.
Analysts need to adjust their expectations in regards to export sales and shipments, because neither is going to produce big numbers in the months ahead considering how little remains left to be sold and shipped!
