This week the Chinese government started to auction off some its huge stockpile to local mills starved for cotton, at weighted average prices of around 137-140 cents/lb, or over 60 cents above where NY futures are currently trading. Some analysts see these Reserve sales as a bearish omen, but we would argue that unless China drops its prices considerably and thereby manages to throttle the flow of imports down to a trickle, it is not going to impact world prices negatively.

In fact, it doesn’t take a lot of imagination to make a ‘glass half full’ case in conjunction with these Reserve sales. For example, the Chinese government could easily arbitrage this huge gap that exists between local and imported prices by auctioning off stocks at 137 cents and importing cotton 50 cents cheaper. In doing so, it would be able to achieve two objectives: a) average the price of its inventory down and b) close the price gap to the ROW, thereby erasing the competitive disadvantage that Chinese mills face vis-à-vis foreign competitors. We are not suggesting that the Chinese government is actually intending to do this; we simply try to point out that there isn’t just one possible (bearish) outcome when it comes to Chinese reserve stocks.

So where do we go from here? The market has arrived at a crossroads , closing near the upper boundary of an 8-month trading range. The technical picture looks supportive and if the 78 cents support level is taken out, we would probably see a lot of new spec buying enter the scene. With the trade already 10 million bales net short, we wonder how much resistance it could muster to oppose any new spec buying. There is a decent chance for the market to explode to the upside and such a move would definitely carry it a lot farther than just a cent or two. On the other hand, if resistance holds over the next couple of sessions, we may get a ‘double-top’ formation and prices may retreat towards 75 cents. Regardless of what happens in the very near term, we still see higher prices ahead down the road.

Plexus Cotton Limited