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New York cotton market up
21
Jan '12
Plexus Cotton reports that NY futures continued to move higher, as March gained another 248 points to close at 98.17 cents. The market managed to extend its rally this week thanks to renewed spec buying. A week ago we felt that a correction was due once the index fund rebalancing was out of the way, but a constructive chart picture along with some bullish news out of China and an improving economic outlook brought some more sidelined speculators back into the fray.

Helping the bullish cause were rumors that the world's two largest cotton producers, China and India, may have smaller crops than what is currently estimated by the USDA. The National Bureau of Statistics has the Chinese crop at just 30.3 million bales (6.6 million tons), which would be significantly lower than the USDA's 33.5 million bales.

This is not the first time we've heard news of a potentially lower crop in China, as about a month ago the Ministry of Agriculture pegged the crop at just 6.5 million tons (29.9 million bales). It is difficult to judge whether these lower crop estimates have any merit, but they have introduced an element of uncertainty that makes the shorts uneasy.

The story is similar in India, where slow arrival figures are prompting traders to lower their crop expectations, with many private estimates now at no more than 32.5 to 33.5 million local bales (25.4 to 26.2 million statistical bales). This would be some 0.8 to 1.6 million bales below the current USDA estimate of 27.0 million statistical bales.

In other words, the market is suddenly confronted with the possibility that global production may have to be scaled back, possibly by some 2 million bales or more. At the same time we may see global mill use recover from what we believe is an overly pessimistic number at 110.0 million bales. Therefore, the current estimate of a seasonal production surplus of 12.85 million bales may shrink in the months ahead, perhaps to as low as 8 or 9 million bales. Combine that with the fact that China's Reserve has been aggressively siphoning off supply to the tune of 16.0 million statistical bales so far (of which 4.5 million are imports), and we may actually end up with an artificially tight market.

We have long held the belief that the huge price gap between China's domestic market (135-140 cents) and the international market (A-index at 102.25 cents) would sooner or later have to narrow again. In order for this arbitrage to take place we need Chinese imports. Even though an official announcement is still pending, it now looks like an additional 1.1 million tons in sliding scale quotas will be issued shortly, which would be in addition to the 0.9 million tons Tariff Rate Quota (TRQ). Once Chinese buyers are armed with these additional 2.0 million tons of buying power, the idea is that they will take advantage of the much cheaper international offers and thereby bid prices up.

The market doesn't seem to be fully aware of the fact that China has already been a very active importer in the first five months of the current season. Last month alone China imported 790'000 tons (3.6 million bales), which was a record for a single month, beating the previous mark of March 2006 by nearly 300'000 tons. Total Chinese imports between August and December are already amounting to 1.88 million tons or 8.6 million statistical bales. This means that China is well on its way to meet or exceed the current import projection of 16.5 million bales by the USDA.

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