NY cotton futures end slightly lower this week

This is the reason behind December’s relative strength versus March. Also, the fact that the certified stock has dropped quite considerably over the last couple of weeks, going from 132’000 bales on July 10 to just 59’000 bales today, suggests that there isn’t much cotton to spare in the coming months. Short sellers are therefore quite wary of December - rightly so!

When we look at the current cotton market, we see a lot of similarities to the sugar market, or rather the two sugar markets. As you may know, sugar is traded in two separate futures contracts, a world contract and a US contract. The reason for this is that the US sugar market is being insulated from world prices through domestic support and import quotas. 

This has resulted in US sugar trading at a substantial premium over world sugar for decades. Sounds familiar? All we need to do is switch US sugar for Chinese cotton and we too have a tale of two markets. China has created a price island as well via its domestic support and import quotas, and its domestic market is still priced at over 130 cents/lb, or about 50 cents above the A-index and 60 cents above NY futures.

The link between the Chinese market and the world market exists mainly via imports, be it raw cotton or yarn. This season China has already imported 22.6 million statistical bales and it is likely to surpass the USDA estimate of 23.25 million bales. By allowing a massive amount of imports in at much cheaper world prices, China has thrown its mills a lifeline, while at the same time supporting farmers by absorbing 3.1 million tons of domestic cotton into its strategic reserve at prices of over 140 cents/lb. 

However, common sense dictates that this modus operandi can’t go on forever. China cannot indefinitely increase its strategic reserve, although it has already promised farmers to once again buy their cotton at even higher prices than last year.

Something has to give, although we are not quite clear yet what it will be. Reduced cotton imports, a shift of cotton to food acres and possibly offering reserve stocks to domestic mills with some kind of an incentive are all within the realm of possibilities. One trend that is clearly emerging is that Chinese mills are importing yarn at a record pace, thereby taking advantage of the much cheaper cotton price elsewhere and the fact that there are no import quotas on yarn.

Pakistan and India are the two main beneficiaries of this trend so far, which will only grow stronger while this huge price difference between China and the world market remains. We feel that the statistics are not adequately reflecting this dynamic yet and that we should eventually see a pronounced increase in mill use in the aforementioned origins.