In a matter of just three weeks the futures market has gone from being one of the cheapest suppliers to becoming one of the best buyers! On November 22, when spot December entered the notice period, it traded as low as 73.79 and closed that session at 75.21 cents, making the certified stock one of the most attractive lots of cash cotton available.
It is therefore not surprising that there were at least three different takers ready to receive 260’000 bales of certified cotton, most of which has since been de-certified. As of this morning, the remaining certified stock amounted to less than 60’000 bales, with about 4’000 bales awaiting review.
By contrast, with the spot futures contract now trading at over 83 cents, which equates to a landed Far East price in the mid-90s for high grades, US cotton is currently no longer able to compete against Indian or West African styles in the mid-to-high 80s. The US has done what it needed to do, namely price itself out of the market, after it had sold nearly 2.5 million statistical bales over the last two months.
The US simply couldn’t keep on selling at this pace, since export sales have already reached around 7.1 million statistical bales, which combined with 3.6 million domestic requirements adds up to 10.7 million bales in total commitments. With the USDA still predicting a US crop of just 13.1 million bales, there are only 2.4 million statistical bales left for sale before the entire crop is committed and we start using up beginning stocks.
In other words, at 200’000 bales a week the balance of the crop would be sold by early March and at 100’000 bales a week it would take until early June. Needless to say that the US needed to step on the breaks and it has done so with this rally, as we expect sales to drop off significantly.
This week’s USDA supply/demand report contained only minor changes, as the USDA shuffled some numbers in India going back over three seasons and lowered Chinese production by another 500’000 bales. On the trade front there were some notable changes as the USDA increased Indian exports from 7.0 to 7.5 million bales at the expense of lower exports from Australia, Uzbekistan, and Turkmenistan, while Brazilian exports were cut by 300’000 bales due to slower than expected shipments.
However, the numbers that matter most in regards to international prices, the ROW production surplus in relation to Chinese imports, were basically unchanged as the USDA still predicts that Chinese imports of 11.0 million bales will neutralize the expected 11.15 million bales surplus in the rest of the world. In other words, we should have more or less the same amount of stocks to work with at the end of this season as we did last summer.
There was an interesting development on Capitol Hill that has the potential to impact the price of cotton over the coming years. A group of ten US Senators is sponsoring a bipartisan bill to eliminate the corn ethanol mandate, which if passed would likely lead to a reduction in corn consumption.
Currently about 39.5% of US corn goes to the ethanol industry, of which 27.3% turns into ethanol and 12.3% re-enters the feed market in the form of distillers grain or corn gluten. To put this into perspective, the acreage that is used to produce corn for ethanol in the US is over three times larger than the entire cotton acreage.
If this bill were to pass and ethanol demand would no longer be supported by a mandate, it could potentially free up millions of corn acres that would then become available for other crops such as soybeans, wheat or cotton. The bill is likely to face stiff opposition from farm and ethanol lobbies, but this is definitely something we need to keep an eye on!
So where do we go from here? By completing a “rounding bottom” and reclaiming the important 82.00 cents level, which served as an important support line from early February to late October, the market has, in impressing fashion, managed to dig itself out of the hole it fell into a little over two months ago.
However, in order to keep the upside momentum going, we need to see greater spec involvement. While there has been some spec buying and short covering over the last couple of sessions, a lot more is needed to keep this rally going.
We do feel that the market is getting the specs’ attention, since a) it went through resistance at 81.70 cents with relative ease, b) the market is inverted and c) it closed above the 50-day and 100-day moving averages in the last two sessions. The only deterrent at the moment is that the RSI and Stochastics are in overbought territory, which means that the market may have to offer a pullback first for specs to move in from the sidelines.
While the technical action looks constructive, the market is getting a bit pricey from a fundamental point of view. We therefore feel that any spec-sponsored advance towards 85 cents will likely run into a wall of trade selling. The increase in May and July open interest over the last couple of sessions is an indication that grower selling from Southern Hemisphere producers will intensify as the market moves higher.
Also, with the futures market paying more than mills in Asia, it will attract a lot of cotton to the board. In this regard we would like to remind readers that starting with the March 2014 contract, a US bale sitting in a certified warehouse can now very easily be converted into certified cotton under the new “Smith-Doxey Registration”, which allows the original bale class to be used for certification.
