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July cotton futures resemble casino than hedging vehicle
30
Jun '12
We can’t wait for the July contract to finally leave the board, because over the last couple of weeks it reminded us more of a casino than a legitimate hedging vehicle. When we look at this morning’s US export sales report, which showed big cancellations in China after two weeks of huge increases, we get the impression that some clever operators may have used the July contract for a classical ‘pump and dump’ play, inflicting considerable pain on many unsuspecting market participants while enriching themselves in the process.

We hope that we are wrong with our suspicion, but it wouldn’t hurt for regulators to take a closer look as to whether everyone’s story checks out in regards to these large Chinese sales and subsequent cancellations.

Plexus Cotton Limited reported that US export sales for the week ending June 21 showed a net reduction of 599’200 running bales for the current marketing year, as China cancelled 618’300 running bales, while commitments for the 2012/13 marketing year increased by 87’900 running bales.

Rather than focusing on reported sales, especially when they involve China, it may make more sense to instead look at how many bales have actually been exported. So far this number amounts to 10.5 million statistical bales, with outstanding commitments currently reported at 2.4 million bales for the current marketing year and 2.5 million bales for shipment August onwards.

With July all but history, we now have a board that is once again reflecting carrying charges. Since early 2010 the spot month has for the most part traded at an inversion, reflecting a tight US balance sheet, but with US and global stocks projected to be plentiful next season, this is changing.

When we look at the current US supply/demand situation, we started the season with 18.2 million bales of supply (2.6 million beginning stocks and 15.6 million crop), of which 3.5 million go to domestic mills this season and 10.5 million have so far been exported. This leaves around 4.2 million bales, to which we add a projected crop of around 18.0 million bales next season, giving us an estimated supply of around 22.2 million.

Against that we have current export commitments of 4.9 million bales and next year’s domestic mill use of around 3.5 million bales, which leaves some 13.8 million bales available for sale.

This means that the US will have to sell another 10 million bales over the course of next season, possibly more if the crop turns out to be bigger than 18 million bales, which seems like a tall order. However, as we have tried to explain in one of our previous reports, since China continues to take advantage of these much cheaper global prices and keeps importing more than its seasonal shortfall, and the rest of the world has only a very small production surplus next season, we don’t foresee a lot of pressure on US prices.

If the market continues to sag from here, growers will stick their cotton in the loan and wait for rallies before they are letting it go. Also, at current prices it is quite conceivable that demand will improve, as cotton will reclaim at least some of the volume it lost to man-made fibers during last year’s bull market.

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