NY cotton futures climb higher this week

28 Apr '12

6 min read

China has not only been an active importer of cotton, but since foreign yarn is made from much cheaper cotton as well and spinning is not a labor-intensive process, there has been quite an increase in cotton yarn imports recently.

In the first quarter, cotton yarn imports rose by nearly 50% to 264'004 tons, with Pakistan and India supplying more than two-thirds of the total. On a net basis (yarn imports minus yarn exports), China took in 179'318 tons in the first quarter, which compares to just 77'531 tons a year earlier.

The latest CFTC report as of April 17, which includes futures and options, revealed that large and small speculators had basically a flat position at just 0.1 million bales net long although they still carry relatively large outright positions at 6.1 million bales long and 6.0 million bales short. Index funds had a net long position of 7.5 million bales, while the trade was on the other side with a 7.7 million bales net short (5.7 million long and 13.4 million short). We are a bit concerned about this large trade short position, especially the 13.4 million bales in outright shorts.

Although some of these shorts belong to new crop, the majority of them are in July. Since the US has only about 2 million bales for sale this season, these shorts are mainly against long positions in origins like Australia, Brazil, or the many consignments that clutter Chinese ports at the moment. Additionally there are still about 2 million bales in unfixed on-call sales, against which shippers may have sold futures to lock in the price.

Since China still seems to be active on the import front, especially if an additional quota were to be released, and since mills all over the globe are not well covered, a lot of these basis-long positions should find a home over the next couple of months, which would mean that short hedges get bought back.

This net buying in July could trigger some technical buying, which would prompt specs to jump into action, both in terms of new buying as well as short-covering. Since Index funds, who hold the biggest block of longs, will not be active for another 5 or 6 weeks, the set-up for a short-covering rally in July seems to be in place.

So where do we go from here? Although the long-term sideways trend is still very much in force and we don't expect that to change anytime soon, it looks like July is ready to generate some short-term momentum to the upside which could propel values into the high-90's.

With China once again lurking on the import front, shorts need to be on alert and should be ready to get out of harm's way if July were to close above the 94.00 cents resistance area. December is still a different story! Although it may get dragged along by a July rally, the fundamentals going forward are still bearish and we would use strength to sell into December, preferably with the use of options, which are relatively cheap at current volatility near 20%.

Plexus Cotton Limited

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