NY cotton futures came under light pressure this week

We believe that the strong rallies in soybeans and corn helped to mitigate the report’s bearish impact on cotton prices today. Corn and soybeans both showed less demand destruction than feared and ending stocks for 2012/13 are projected to be at critically low levels. With November’13 soybeans closing today at 13.53 dollars/bushel and with December’13 cotton settling at 75.02 cents/lb, the ratio between the two has now widened to 18-to-1, which means that cotton is roughly 50% undervalued in regards to soybeans, assuming that a more traditional ratio is in the 11-to-1 or 12-to-1 range. 

So where do we go from here? Based on the rather depressing statistics cotton should be selling off, but it isn’t! This may be due to quality concerns, as the US crop seems to yield less tenderable grades than usual, which makes it dangerous to be the cheapest high grades short. We consider NY futures to be among the most affordable high grades around the globe at the moment. Maybe the balance of the crop will show some quality improvement, which could lead to renewed pressure, but for now there aren’t too many willing short sellers around as the CFTC report has shown.

Further we need to consider that cotton doesn’t exist in isolation. With grains and soybeans offering more rewarding alternatives next season, how much lower can cotton go, particularly the December’13 contract? If new crop prices start to bottom out, as we believe, they will in turn act as an anchor to current crop prices. Granted, there is not enough carry on the board yet and current crop prices may therefore slip another 3 or 4 cents in relation to Dec’13, but eventually this backstop should start to work.

Depending on how the quality of the US crop eventually turns out, the market may have some additional room to the downside, but we would be surprised to see values dip below 65 cents. On the other hand, if the lack of tenderable grades persists we could see the spot month retest its recent highs. 

Let’s not forget that speculators added a large amount of new shorts over the last few weeks, which sets the market up for a short-covering rally. We therefore see the market in a continued sideways trend between 65 and 77 cents, which has been in force for nearly five months now. A more friendly new crop scenario will eventually come into the picture, but probably not before the beginning of next year.

Plexus Cotton Limited