Cotton market confused since release of USDA report

In 2010/11 we had worldwide inventories at 49.4 million bales and by the end of next season they are predicted to be nearly twice as large at 92.7 million bales. However, the reality is that we have a split market, with China drowning in cotton, yet importing more with reckless abandon, while the rest of the world is looking at the second lowest ending stocks in a decade.

Sooner or later there will come a time when China will no longer allow its stock levels to rise by ten million bales a year, but some sources believe that we won’t see a major policy shift until early next year.

While in a free market environment prices would probably collapse to 50 cents, the current set-up may actually force values to rise to a dollar, especially if the Northern Hemisphere were to encounter some crop problems. With the long-term outlook so unpredictable, traders will likely become less inclined to hold large forward positions and will instead focus more on nearby business.

The futures market seems to already reflect that, since we have an unusually low open interest in December (58’518 contracts) compared to July (122’502 contracts). The last time we had such a low ratio was in 2009, after the financial crisis led to a lack of visibility.

The fact that we have so many outstanding bets on July could lead to some volatile swings in the weeks ahead. The index fund roll will provide much needed liquidity for July shorts to get out or roll forward, but beyond that a lot will depend on what the spec longs decide to do.

Some traders hope for technical weakness to flush out the spec longs, similar to what happened two month ago when specs liquidated over 4 million bales in matter of weeks.

However, if support holds and Texas doesn’t get rain soon, it may this time around be the shorts that blink first. In view of this huge open interest in July we expect to see a rather erratic and volatile market over the next four to five weeks. Given the low stock levels in the ROW and the current Texas weather, the risk seems to be greater to the upside.

The same goes for the longer-term outlook! As long as China continues to take away vast amounts of cotton from the ROW, we are likely to see firmer prices ahead.

Plexus Cotton Limited