Last week we talked about the “triangle formation” on the chart, which was setting the market up for an eventual breakout on either side. To most traders’ surprise last Friday’s breakout occurred to the upside, which was against the prevailing long-term downtrend. This reversal triggered a number of buy stops and invited new spec buying, propelling the market nearly 500 points higher in just two sessions. Daily volume more than doubled to 24’000 contracts on Friday and 22’000 contracts on Monday, with nearly all of the action happening in the December contract. Since then volume has moderated quite a bit, which is a warning sign that upside momentum may be stalling.
Also somewhat surprising is the ease with which the market has been able to advance. The trade seemed to offer only limited resistance until values reached above 75 cents and even now there is not much conviction behind any selling that’s out there. We believe that this is due to the fact that the cash market is currently very tight and that merchants, who may be short nearby shipments, are not inclined to aggressively sell futures at the moment.
The question is why does the market feel so tight in light of a record 66.7 million bales in global beginning stocks on August 1st? In order to answer this question we need to take a closer look at where these stocks are located and at what price they may be available. On top of the list is China with 27.3 million bales, but as we all know, these bales have an average price tag of more than 50 cents above world market prices and they aren’t even in play at the moment. Next in line is Brazil with 8.0 million bales in beginning stocks, but most of these bales have already been committed and with Brazil likely to reduce its plantings by 30 percent or more this season, we don’t expect any price pressure from that origin in the foreseeable future.
India is the third largest holder of stocks with 7.3 million statistical bales, but don’t expect cheap offers to come out of India anytime soon. To the contrary, India has been a keen importer recently and local prices are very firm, with high grades currently fetching around 90 cents domestically. The fact that China has become a strong importer of yarn this year seems to have boosted mill use in India. The same goes for neighboring Pakistan, which has beginning stocks of 3.2 million statistical bales according to the USDA. Although local prices in Pakistan are not quite as high as in India, they are nevertheless several cents above the world market.
The above four countries account for 45.8 million bales or more than two-thirds of global beginning stocks and they all have a sizeable domestic textile industry, which tends to act in support of prices. That’s not the case for the next string of origins, Australia, Central Asian, African growths and the US, which are all highly dependent on exports.
Australia, with 3.4 million bales in beginning stocks, some of which has yet to be ginned, still cotton available, but its price is relatively expensive. The same is true for Uzbekistan and Turkmenistan, which according to the USDA are starting the season with a combined 2.5 million bales, although private estimates have stocks as high as 3.5 to 4.0 million bales. So far the governments of these two origins have refused to discount prices in order to promote sales and potential buyers have therefore been looking for more attractive options, such as African growths or US cotton. While African growths have been a viable option for mills in recent months, they represent a relatively small supply in the big scheme of things, since East and West Africa produce only about 4.5 million bales combined and even though beginning stocks on August 1 were still estimated at 2.4 million bales, most of these bales have already been committed.
With other origins either not available or too pricey, the US has become the residual supplier for mills in recent months, especially after the futures market caved in by 20 cents in early May. With buyers turning to the US, sales have accelerated to the point of being overcommitted, which has lead to a firming of the cash basis. As we have pointed out last week, the US will begin the season with just 3.1 million bales of inventory, against which there are currently export sales of 4.4 million statistical bales and domestic mill requirements of around 0.9 million over the next three months. In other words, we don’t expect to see any price pressure from the US until new crop arrives in volume.
So where do we go from here? We believe that it is all a matter of timing! For reasons explained above, we are currently dealing with a tight physical market, especially in the US. This has allowed the futures market to rise in a temporary void of selling, boosted by spec buying. This dynamic is likely to prevail until new crop arrives or until prices move high enough to bring stocks in Central Asia, Australia as well as sizeable consignments in Chinese ports into the picture. Barring any unforeseen crop problems, we should see new crop weigh on prices by late September or early October. In the longer term a lot will depend on what happens with planting intentions. Given the record prices in grains and soybeans, we have to expect a sizeable drop in cotton acreage next season. Tomorrow’s important USDA supply/demand report will set the tone in that regard.