The next monthly USDA update of cotton’s balance sheet in the US and abroad will be issued Thurs, March 9 at 8:30 AM EST. As mentioned last month, into the third quarter of the marketing year (Feb-Apr) production in the northern hemisphere is typically close to its final level and consumption has made the necessary adjustments in response to supply availability via procuring cotton as needed until new crop is accessible. This year is anything but typical especially for consumption as the mixed data is providing fodder for both bulls and bears. Beyond old crop, official data for new crop will not be out until the May 11 report but the Dec 11 contract which best represents 2011/12 season is divorcing itself from the nearby months.
US 2010/11 Cotton Supply & Demand – In the US, unlike overseas, production and therefore supply have been settled although the final ginnings report due out this month might lead to small revisions in the May annual report. At 21.3 mln statistical (480-lb) bales, supply is nearly 3 mln bales above the 2009/10 crop year but as mentioned in past reports, is a 10-year low. As alluded to in the introduction, if this was a typical year, the US would find itself as a residual supplier of cotton to foreign mills but for the first time in recent history, export commitments stand at 99% of the USDA estimate with absolutely no wiggle room for additional sales given the low forecasted ending stocks level. Latest export data after 30 weeks place commitments at 15.09 mln running bales and shipments up to 7.51 mln bales, 49% of the official forecast. If and there always is one, if every bale sold was going to be shipped there would no room for change but as US cotton has shot beyond the 2.00 mark, cracks are becoming more apparent with demand rationing taking greater hold.
Asian mills more so those in China than elsewhere have been successful in passing along the resulting higher price of yarn, cloth, etc due in part to their near absolute control over clients downstream including retailers. Despite evidence from Cotton Inc that suggests the price increase cotton has gone through should only result in very minor increases for retailers, they are being subjected to much higher costs. Since their profit margins are historically thin, they were and are only able to absorb so much of the higher cost per unit resulting in many announcing price increases this quarter. Since the full brunt of cotton’s high price has yet to be passed through, additional price increases are likely although the consumer will have the last say whether they are willing to pay more for 1) all cotton/mostly cotton products due to fiber preference, 2) chose cotton due to its “green” label or 3) accept products with other natural and/or manmade fibers because of price. Hence, US merchants have been able to make modest sales of old crop even at these very high prices but they also encountering a new issue, a few foreign mills are unable or unwilling to price on-call cotton because of its prohibitive cost. Over the past few weeks, the above mentioned cracks with demand have become more apparent with mills from specific countries such as Turkey not pricing cotton already purchased in the last week prior to FND with the March 11 contract or on set-backs as occurred the week of Feb 21-25. Cotlook has mentioned recently the level of hesitation with pricing is fairly high and since Turkey is the second largest buyer of US cotton, their mills’ willingness to price on unfixed contracts is critical. Referencing US export data from the week ending Feb 24, of the 2.22 mln running purchased, 1.02 mln have been shipped leaving 1.20 mln to be shipped if prices cooperate. At this point, it is impossible to say how much cotton sold to Turkey or other countries will not be priced but the direction of US futures has been to the upside and the higher that trend is maintained the more cotton that will not be priced. Merchants have a couple of choices in the event of mills who opt not to fulfill their contract, either take them to arbitration and seek repayment over time or re-sell that same cotton, if possible, although any repayment would be substantially reduced. The on-call report as of Feb 18 showed an increase in May unfixed contracts of 2,194, presumably most of which involved mills rolling March positions forward delaying their pricing decision in the hope of cheaper prices. If those cheaper prices do not prevail, more of the May unfixed contracts, 21,891 as of Feb 25, may be rolled or abandoned. Based on the increased number of problems arising for foreign mills including delivery issues (which is behind the lower NCC estimate), I am lowering my export estimate by 100k to 15.6 mln statistical bales vs Washington’s of 15.75 mln. By the time the May contract has gone into notice, Apr 25, we should know if all of the above mentioned contracts were priced and if not, the consequences for the market. I am also leaving domestic usage at 3.5 mln bales although data in the first 6 months suggest a stronger figure. Similar to foreign mills, those in the US are likely to succumb to the pricing pressures shrinking their consumption by 100K bales vs the USDA estimate. Total demand at 19.10 mln bales is 250K bales below the WAOB figure and if prices continue to remain as high as they are or move higher, some additional loss of demand will occur. Ending stocks are forecast at 2.17 mln bales vs the official Feb 1 of 1.90 mln. As a reminder US and foreign stocks were pegged at the lowest possible level by the WAOB from their November 2010 forward reports and consumption backed out as a result. Fair to say, the pending “showdown” may factor into their consumption forecasts in the last 3-4 months of the crop year.
US 2011/12 Cotton Supply & Use – In light of cotton’s higher price in the past two months for new crop and various comments from commercial sources regarding US producers’ preference for cotton over corn or soybeans, I am tentatively raising my projection for US area to 13.2 mln acres. I will provide a region/state breakdown and any last minute tweaking in front of the NASS Planting Intentions due out Thurs, Mar 31.
Area in the Southwest region, which includes Texas could be much higher exceeding that of the past 30 years but current dryness warrants a higher abandonment of 13.4 % (same as the 3-year average) resulting in a national harvested figure of 11.47 mln acres. My planted figure is slightly above that USDA Ag Outlook forum number but the harvested figure is slightly lower. Employing a 5-year average yield of 821 lbs/ac pencils out to a crop of 19.6 mln bales, 500K higher than my February estimate. When combined with a slightly higher carry-in, supply could reach 21.8 mln bales, also a half mln bales higher than this year. Demand for US cotton will depend greatly on 1) how much supplies rebound in key foreign countries and 2) how much overseas mills seek to replenish stocks. Tentatively, the higher supply assuming prices are competitive should allow exports to range from 13.5-15 mln bales with domestic usage a hair higher at 3.6 mln bales. My guesstimate for total demand and that is all it can be at this time is 18.1 mln bales, about 1 mln less than the current year but above the two previous years. Ending stocks from a crop in the mid-19 mln range and exports 1 mln less than in 2010/11 should help stocks rebuild to a more comfortable 3.7 mln bales. One caveat, if old crop shipments are delayed beyond Jul 31, it would inflate the new crop export figure but not necessarily change carryout.
Potential price impact and possible conclusions
As was the case with the past few USDA reports, this one may not carry much weight beyond the first hour or two as a lack of selling from commercials is keeping prices higher on a day-to-day basis. As described to some of you, imagine a bakery with a long line stretching out the door and down the sidewalk. Until a customer is allowed to buy a loaf of bread and leaves the door, the next customer cannot step up for the next loaf. Until the shopkeeper is willing to sell another loaf, buyers have to bid the price of bread higher enticing another (bakery) trader to risk going short or take profits on his long(s). The ever higher prices seem to be scaring off some specs as the three key reports from the exchange and CFTC continue to show decreased spec longs and in some instances short covering by the trade due to the occasional mill fixations with old/new business.
However, new crop is not participating in the old crop rally and per commercial sources according to Cotlook, the same disconnect also exists between cash and old crop futures. In its most recent price commentary, Cotlook put the current situation very succinctly; they said “offering rates appear well out of reach for many mill buyers at present, particularly as local prices in a number of key import markets appear attractive by comparison.” When the current situation with old crop implodes, it will not be pretty and as also mentioned to some of you, I want to be as far away as possible. New crop by late this month and certainly early April will be guided by weather and increasingly its own fundamentals. By late May/early June, the Dec 11 contract should be the lead month with regards to open interest. What becomes of old crop by then is unknown but cotton moving from the southern hemisphere may moderate its behavior but the lack of players could also make for a very dangerous market.