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NY futures up despite gloomy economic outlook
Sep '11
NY futures have moved sharply higher since our last report two weeks ago, with December gaining no less than 1064 points during that period, closing at 113.63 cents.

Before breaking out to the upside on Wednesday, the market had closed the previous 12 sessions in a very narrow band of just 335 points, between 102.99 cents and 106.34 cents, with open interest showing hardly any change at all. But just when everyone was getting used to a dull sideways trend, the market found a way to escape the boredom. Although some point to the recent floods in Pakistan and the rains in India as the cause for this rally, we believe that it was a wide variety of factors, both fundamental and technical, that led to this bullish move.

We have repeatedly talked about the lopsided position by the trade when it comes to US cotton, since merchants are short physicals as well as NY futures. Export sales of 7.0 million statistical bales (not counting sales with optional origins) and domestic mill requirements of 3.8 million bales add up to commitments of nearly 11 million bales, against which there were less than 3 million bales in beginning stocks as of August 1st.

This means that it will take a while until new crop is sufficiently available to cover all these commitments and then there is the quality angle that may further complicate matters this season. West Texas is likely to produce a lot of 'popcorn cotton' due to heat stress, while the Mid-South and Southeast are exposed to very active tropical weather at the moment.

In addition to the physical short, the trade also has a substantial NY futures exposure, since it has sold a lot of contracts as hedges against long positions in foreign growths. The latest CFTC report showed the trade 9.0 million bales net short in futures and options, which leaves them vulnerable to a short squeeze. Even without a squeeze the trade will likely be a net buyer of futures over the coming months, as it will lift short hedges against sales of foreign growths.

Enquiries are definitely picking up, as mills are in the process of replenishing their inventories. Yarn prices have started to rebound as well and we are seeing some encouraging signs on the retail front. "Back-to-school" sales in the US were surprisingly strong despite the gloomy economic outlook, as sales at major chain stores rose 4.4% year-over-year in August.

Furthermore, the International Council of Shopping Centers estimates that sales will rise 3.5% during the November and December holiday period, which accounts for about 40% of annual turnover. We suspect that cotton consumption at 113.93 million bales for the 2010/11-season and 115.18 million bales for the current season may be slightly understated and perhaps the market is starting to feel the same way.

The fact that the Chinese Reserve is, as of September 8, actively procuring cotton in an effort to restock its depleted inventory, is another importantelement of support for the market. The first procurement auction for 24'300 tons failed to attract any sellers, which is seen as a bullish sign by the market. The buying program by the Reserve is intended to run through March 31, 2012, and should provide decent support underneath the market.

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