NY futures have advanced marginally since our last report on November 29, with March gaining 121 points to close at 74.56 cents. A minor technical buy signal and a slightly less bearish USDA report provided the market with a bit of boost this week, although strong overhead resistance is likely to keep any upside momentum in check for now.
On Tuesday the market was able to break above a triangle formation dating back to late August, which prompted some new spec buying and forced additional shorts to cover. The increase in volume and the jump in open interest of around 3’700 contracts over the last two sessions give the move some validity, but there is still plenty of trade selling to chew through before the market has a chance to break out of its long-term sideways trend.
US export sales continued to impress, as another 299’500 running bales of Upland and Pima cotton were sold for the current marketing year last week, along with 26’000 bales for next season. Once again we had broad-based participation, with no less than 17 markets on the buyers list. Over the last five weeks sales have amounted to 2.0 million statistical bales for the current marketing year and 0.3 million bales for 2013/14, bringing total commitments to 8.5 million and 0.5 million statistical bales, respectively.
The latest USDA report was seen as mildly supportive, because the US balance sheet tightened somewhat due to a smaller crop and higher exports, while global stocks outside China saw a reduction of 1.2 million to 42.0 million bales. This reduction was mainly the result of a smaller US crop, a revision in Turkish beginning stocks going back several seasons and an increase in Chinese imports.
Although stocks outside China are still projected to be 3.0 million bales larger than last season and 3.7 million bales more than they were in 2010/11, they are by no means at depressing levels, especially when we consider a potentially large drop in plantings next spring. As we have mentioned before, when we talk about the global stock situation, we need to factor the price of these stocks into the equation. While international cotton carries a price tag of 80 to 90 cents landed Far East, Chinese cotton as measured by the CC-index is still around 50 cents more expensive.
In other words, there is plenty of room for international prices to improve before they bump into the massive ceiling of Chinese Reserve stocks. Unless China shuts all its doors to imports, be it in the form of raw cotton, yarn or grey cloth, the balance sheet in the rest of the world is likely to tighten quite considerably next season, which is definitely not bearish to prices.
Over the last five seasons China has absorbed more or less all the seasonal surplus that the rest of the world has produced. According to USDA numbers, the ROW produced a combined 64.2 million bales in surplus cotton between 2008/09 and 2012/13, whereas Chinese imports are pegged at a cumulative 65.9 million during these same five seasons.
A common fear among traders is that China will suddenly close its doors to imports and releases the massive stocks it has accumulated. While this is certainly a possibility, it doesn’t mean that prices in the rest of the world would have to collapse because of it, for the following reasons:
In the current season, the rest of the world produced a seasonal surplus of 14.4 million bales, with a crop of 85.4 million bales and mill use at 71.0 million bales. A drop of 15% in production due to a significant reduction in plantings (12.8 million bales) and a slight increase in consumption of let’s say 2% (1.4 million bales) would erase the current seasonal surplus and keep stocks at the same level, even if China had its doors firmly shut to all imports.
China will likely continue to import a certain amount of cotton and/or yarn, be it because of the TRQ (tariff rate quota of 894’000 tons) or because attractive yarn and grey cloth prices offer an alternative to expensive domestic cotton prices.
If Chinese mills have less access to cheap imports and are forced to swallow expensive domestic cotton instead, they will continue to lose competitiveness in export markets, which in turn will shift consumption further to places like Pakistan, India, Turkey or Vietnam, just to name a few.
China certainly has a lot of stocks, with Reserve cotton likely to amount to over 9 million tons by the second quarter of next year. However, it is highly unlikely that China will become a net exporter of cotton anytime soon and dump its expensive stocks on a world market that is over 50 cents lower. What is more likely in our opinion is that China is going to reduce its cotton crop (switching to food crops) and then subsidizes the drop in production with its Reserve stocks over the next two or three seasons.
China definitely holds the key to the cotton market going forward and while most analysts believe that the Chinese stock situation is depressing cotton prices, we feel that it is also possible that China creates a vacuum in which international prices trend higher. That may happen if we get a sharp drop in acreage in the rest of the world, while China keeps importing a limited amount of cotton and yarn (let’s say 6-8 million bales), thereby tightening the balance sheet in the rest of the world.
So where do we go from here? Although the bulls may claim a minor technical victory this week, the market remains well within the confines of a 7-month sideways trend. In order to escape from this range, March would have to firmly establish itself above the 78.02 cents high of August 31. We doubt that this will happen over the holiday period, but early next year the market may adopt a more positive outlook as planting discussions enter the picture.