NY futures traded sideways to slightly lower this week, as December slipped just 24 points to close at 76.52 cents, while March gave up a more substantial 140 points to close at 77.46 cents.
The March contract, which is now the most active month with an open interest of over 106’000 contracts, came under pressure today after the break of a sideways flag formation triggered some technical selling, forcing March to its lowest close in nearly a year. However, the December contract, which still carries some weight even though its open interest has dropped to just 30’000 contracts, did not confirm the breakdown and stayed clear of its recent low of 75.27 cents.
This week’s divergence between December and March seems to reflect what we have been observing in the physical market, where pipeline stocks are just starting to fill up again, keeping nearby prices relatively well supported, while offering rates for first quarter shipments are being discounted in anticipation of some supply pressure down the road.
Demand has been brisk over the past ten days, as numerous large sales of US, Australian, West African and Brazilian cotton have been reported, with China actively participating. This is encouraging, because traders have been writing China off as a strong importer, which has been one of the key factors behind the market’s weakness. However, as we have learned from past seasons, we need to be careful not to underestimate Chinese imports!
For the first three months of the marketing year, China has already imported 2.83 million statistical bales and we expect strong shipments in November and December to bring this number up to around 5.0 to 5.5 million bales. Beyond that we can almost certainly add the 4.1 million bales of TRQ imports to the tally in 2014 and mills are also counting on a certain amount of processing trade quotas to be released next year. In other words, it is no big stretch to project Chinese imports at over 10 million bales this season and if prices were to fall another three or four cents, this number would grow considerably with the 40% tariff buyers stepping in.
Last Friday’s USDA supply/demand report turned out to be less bearish than anticipated, despite the projected increase in global ending stocks from 94.7 to 95.7 million bales. The numbers that we pay the most attention to are the seasonal production surplus outside China (11.1 million bales) and Chinese imports (11.0 million bales). As you can see, the USDA still believes that Chinese imports will be able to absorb the production surplus in the ROW, thereby keeping stocks outside China from rising. If true, one could argue that prices shouldn’t stray too far from where they were trading this summer, which was about ten percent higher than current levels.
However, we feel that the USDA is at least half a million bales shy on the US crop and there is also room for the Indian number to grow by 0.5 to 0.75 million bales. At the same time Indian mill use may be overstated by half a million bales or more, given the recent slowdown of Chinese yarn imports. In other words, we believe that the ROW production surplus is going to be quite a bit higher than 11.1 million, possibly as high as 13.0 million bales. ROW stocks may therefore increase after all, which is probably the reason why the market has been on the defensive lately.
According to the latest CFTC report, speculators have transitioned to a 0.5 million bales net short position as of November 5, after having been net long 5.5 million bales as recently as October 1. Meanwhile, the trade has cut its net short position to just 5.6 million bales, down from 12.5 million bales five weeks earlier. However, the trade maintains rather large outright positions at 9.2 million long and 14.8 million short. Index funds are currently the only group on the long side with a 6.1 million bales net long position.
So where do we go from here? Today’s technical break would be more meaningful if speculators had a bigger stake in the cotton market. But they are watching mostly from the sidelines these days, with the trade being in control of the action. Physical activity has been quite strong lately, although the market may be transitioning from a tight cash market to a more ample supply situation that may keep some pressure on international prices through the first quarter.
However, strong rumors have it that Chinese reserve sales are about to resume any day now at 18’000 yuan/ton, which would render imports at the 40% tariff feasible in the low-to-mid 70s basis NY futures. We therefore believe that the market has strong support from 75 cents on down, but at the same time we see don’t see much room to the upside either given all the supply that’s becoming available. The market may therefore get stuck in a range between 74/75 cents to the downside and 80/82 cents to the upside in the foreseeable future. Only once the current pile of cotton has been worked down somewhat and if China stays active on the import front will prices have a chance to move higher, which probably won’t be the case until the 2nd or 3rd quarter next year.
Source: Plexus Cotton