With crops in the Northern Hemisphere coming off the field at a rapid pace and with the USDA issuing yet another bearish supply/demand report last Friday, most traders were expecting the market to remain on the defensive this week. However, China once again came to the rescue by buying a large amount of imports over the last few days, with US cotton leading the way.
The “whisper number” has recent sales to China at over a million bales, as the Reserve seems to be intent on bringing down the average cost of its massive stockpile by importing much cheaper international cotton. In doing so, China is not only helping to offset any crop pressure that was about to build in the US, but it has caught many traders off guard, particularly speculators.
When we look at the latest CFTC spec/hedge report as of November 6, we notice that large and small speculators sold 19’865 contracts or nearly 2.0 million bales net during that week, in addition to having sold 11’563 contracts or 1.15 million bales the week before. In other words, speculators have recently sold over three million bales net at prices in the low 70’s, while the trade was on the other side as a net buyer. This is an almost identical set up like month ago, when a similar spec short position triggered a short-covering rally towards 78 cents.
Last Friday the USDA continued its string of bearish reports by raising its estimate of global ending stocks to 80.3 million bales. Although at first glance such a high inventory number may look depressing, the story is not quite as simple as it seems, because these 80 million bales have a wide range of prices. The 37.1 million bales of Chinese inventory are nearly twice as expensive as other sizeable stockpiles around the globe, which can be found in origins like Brazil, the US or India. In other words, while Chinese stocks loom large, they are not necessarily a threat on the trade front.
Quite the opposite is the case! Because Chinese cotton is so expensive, it has led to an absurd situation in which Chinese mills, as well as the Reserve, are desperately trying to import cotton, yarn and grey fabrics in an effort to stay competitive or to average down cost, which leads to an even greater dichotomy between China and the rest of the world.
On the one hand we have China boosting inventories to never before seen levels, while its textile industry is becoming less competitive, and on the other hand we have still relatively tight stock levels in the rest of the world, at a time when mill demand is seeing a revival. For example, in 2009/10 we had ending stocks outside China at 32.5 million bales; in 2010/11 they were at 38.1 million bales and in the 2011/12-season that just ended they amounted to 39.4 million bales. During the course of this season stocks outside China are expected to increase to a comfortable 43.2 million bales according to the USDA, assuming that China doesn’t import more than 11.0 million bales. However, not only do we believe that Chinese imports will exceed 11 million bales, but we also feel that demand in the ROW is understated by several million bales, meaning that stock levels could very well remain below 40 million bales.
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