A slew of bearish technical and fundamental factors put the market under pressure this week.
First we had the breach of a 6-1/2-month uptrend line, which put the spec longs on the defensive, although we have yet to see any widespread spec liquidation, judging by the relatively small change in July open interest over the last two sessions.
Then there was the forecast for rain in West Texas, with most areas around Lubbock expected to receive some moisture over the next couple of days. Further adding to the bearish sentiment this week were reports about slower growth in China as well as some analysts predicting an end to the ‘commodity super-cycle’.
However, while the mood has undoubtedly shifted from cautiously optimistic to bearish, especially with the chart turning over, the overall situation hasn’t really changed much in this bifurcated market.
The global balance sheet has been bearish for quite some time and strong Chinese imports are the only reason why prices aren’t a lot lower. As we have stated before, China has imported nearly 2 million bales a month for the last 21 months and is showing no signs of slowing down. If anything, this drop in prices may actually spark additional buying by China and we have already noticed an increase in activity this week.
A lot of the action this week was in the July/Dec spread, which collapsed from a 70 points inversion to 186 points carry. The large certified stock of 510’000 bales, the relatively high price level of July futures in relation to the cash market and a weakening technical trend have prompted bull spreaders to throw in the towel for now.
However, as soon as July converges with the cash market, it should find strong support, irrespective of its spread to December. This is particularly true this season, since we estimate that there are only about 2 million bales of US cotton left for sale, including the certified stock. Landed Far East prices have not nearly sold off as much as the futures market and we therefore feel that the certified stock should start to attract buyers if July trades at around 79 to 80 cents.
US exports sales for the week ending May 16, when July was trading around 86-87 cents, amounted to 138’100 running bales of Upland and 5’400 bales of Pima for both marketing years. China continued to be the main buyer with 29’800 bales of Upland and 3’200 bales of Pima, followed by 16 other markets.
Shipments were slower than the week before at 254’100 running bales, but still amounted to about 10% of unshipped commitments of currently 2.4 million statistical bales. Total commitments for the current marketing year are now at 13.3 million statistical bales, of which 10.9 million have so far been exported. Sales for the coming season (shipment August onwards) are currently at 1.7 million statistical bales.
The prospect of rain in West Texas has certainly played a part in the market’s weakness this week. Conditions are favorable for storm activity over the next two or three days and possibly into next week, with many stations expected to finally receive some much needed rain.
Whether it will be enough to be called ‘a million bale rain’ remains to be seen, but even if it were, would it dramatically change the current market outlook? In other words, would an extra 1.0 to 1.5 million bales in Texas be reason enough for prices to drop by 5 or 10 cents?
Although a larger than expected US crop would certainly help to improve the tight ROW balance sheet, world prices will primarily be determined by how much China decides to import next season. At the current pace of Chinese imports (2 million bales a month), an extra million bales in Texas equates to just two weeks of Chinese buying.
If imports were to slow down to just one million bales a month next season, as predicted by the USDA, it would stretch it out to four weeks. Nevertheless, we feel that the market is putting too much emphasis on whether Texas will grow an extra million bales or two next season, when it should be focusing on China, who has been dominating the scene by importing well over 40 million bales over the last two seasons!
So where do we go from here? The short-term outlook is bearish, both from a technical as well as a fundamental point of view and the market will have to trade to a level at which it uncovers a decent amount of physical demand. We feel that this should be the case in the 78-80 cents area basis July. In the longer run the market outlook still largely depends on the actions by China.
All indications are that China will continue to import in the foreseeable future and with the futures market once again near 80 cents, we should see increased demand from China as buyers outside the quota system (paying the 40% duty) will become active again. Only once China finally steps on the breaks will the market feel sustained pressure, but most analysts don’t expect to see a major policy shift until early next year.
