After July had fallen to a new low of 66.10 cents on Monday, the selling finally started to subside and buyers came out of their hiding. Last week we talked about the drivers behind the recent collapse in the cotton market, which saw prices drop by over 26 cents between April 23 and June 4. When the spot month traded in the mid-60s earlier this week, most of these negative influences began to fade away, allowing the short-term momentum to reverse to the upside. It seemed as if the various market participants all underwent a sentiment change at around the same time, which allowed the market to rise in a vacuum of limited selling.
Growers were no longer keen in hedging or selling their crops once prices traded in the mid-60s, which in many cases represents a level that is at or below growing cost. US growers in particular are turned off by these low prices and they may instead put their cotton in the government loan at 52 cents and wait it out. If the US crop were to get locked away for some time, it would remove pressure from the market. After the rest-of-the-world produced a surplus of 4.4 million bales in the current season, the USDA now predicts a production shortfall of 6.8 million bales outside the US in 2012/13. Therefore, if US cotton plays ‘hard to get’ in the loan, then this enormous crop pressure that everyone is expecting is less likely to materialize, at least not at depressed price levels.
While merchants and locals were still engaging in some damage control late last week as well as Monday by doing more panic-driven bearish options strategies, this too appeared to eventually run its course. Judging by the latest CFTC report, which showed a small drop in trade longs after two weeks of steep increases, the need to play defense seemed to be a lot less pressing.
Short speculators and chart traders, who base their decisions mainly on technical indicators, had a very successful run in this bearish move and were quick to take their profits once they had confirmation of a short-term trend reversal. This removed yet another source of selling.
Last but not least there was the anticipated shift on the macro side, as money managers once again flipped the switch to “risk on” after they became more confident that a new round of stimulus might be just around the corner. While the Fed has so far resorted to lip service only, China’s rate cut by 25 basis points was enough to embolden some hedge funds to return to riskier assets.
Cotton was clearly benefitting from a wave of buying in outside markets, as stocks and commodities rebounded sharply this week. Food crops were particularly strong, with November soybeans closing at 13.39 dollars/bushel, up 70 cents since last Thursday, after the USDA reported continued strong export sales to China. It becomes increasingly clear that China welcomes every opportunity to buy additional food supplies on weakness. As we have stated a couple of weeks ago, we believe that food demand will be one of the big stories going forward. Unlike seven or eight years ago, when the US did not know what to do with its surplus grain and oilseed stocks, we are now in a situation in which demand will readily absorb whatever food crops the world is able to produce. In such an environment cotton cannot stray too far from its traditional ratios to food prices without risking a significant drop in acreage. Take soybeans for example, where the current ratio to cotton has stretched to over 18-to-1, which compares to a typical ratio of around 11-to-1.
US export sales maintained a decent pace last week, as 136’100 running bales net were sold for the current marketing year and another 69’700 running bales were added to the 2012/13 tally. This brings the two-week total to over 500’000 bales in sales and almost 630’000 bales in shipments. The shipment number is particularly impressive and it helps to alleviate fears of cancellations. For the season total sales now amount to around 12.6 million statistical bales, whereof 9.9 million bales have so far been exported.
While export sales were quite constructive, the fact that West Texas received abundant and widespread precipitation this week was clearly a negative. Some stations reported accumulations of over 5 inches and the region is off to one of its best starts in recent years. With the cotton belt doing quite well as a whole, it should reflect in a higher crop estimate in the upcoming USDA report, as abandonment is likely going to be lower and yields higher than average.
So where do we go from here? Last week we predicted the market would trade in a range between 65 and 78 cents and we are still holding this view. After the market tested the lower end of this range on Monday, it has since rebounded sharply and further short-covering in July may even propel it towards the high 70s. However, while growers are not interested in selling or hedging their crops in the mid-60s, they will most likely seek additional protection from here on up. We feel that the market will eventually run into a wall of selling, which should stop the current momentum in its tracks. We therefore view the current strength as a selling opportunity.