NY Cotton Futures remain under pressure this week

06 Jun '14

6 min read

Next Wednesday’s USDA report should reflect a tighter current crop scenario and a more accommodative new crop situation. Since the US has already shipped 9.3 million bales and there are still 9 weeks to go, there should be enough evidence for the USDA to raise the export target back to 10.6 or 10.7 million bales. This in turn would lower US ending stocks to 2.5 or 2.6 million bales, although it doesn’t really matter whether these remaining US stocks will be shipped in July or a month or two later.

The other current crop number that should draw some attention are Chinese imports, which should see an increase from 12.75 to 13.5 million bales, considering that China has already taken in 11.0 million bales in the first 9 months of the season and that both sales and shipments to China have continued at a fairly brisk pace recently. This would lower ROW ending stocks to around 37.6 million bales, or the tightest they have been since 2011.

On the other hand we should see a much more ample new crop balance sheet! At current conditions a US crop of 16.0-16.5 million bales can be envisioned and due to the sharp drop in Chinese domestic prices of 20% or more compared to last season, we could see a reduction in yarn imports and hence less mill use in some ROW countries. These factors could combine for an increase in ROW stocks to around 43-44 million bales by the end of next season.

So where do we go from here? The market is currently dealing with two completely different supply/demand scenarios – a very tight current crop situation and the promise of record ROW stocks in the coming marketing year. We therefore believe that the futures market accurately reflects this situation, with July deserving its stiff premium over new crop.

The question is how will the market transition from July to December? Will there be a last minute collapse of the inversion or could the opposite happen, with July squeezing some shorts that have overstayed their welcome? Remaining inventories would typically force the inversion to narrow or even go away, but since there may actually be more certified stock wanted than is available, July may simply play its own poker game without regard to what happens after its expiry.

Once July futures are gone, there will be a long five-month gap until December, since October is not actively traded. This makes it quite difficult to price remaining old crop supplies, because there is a certain disconnect between the tight cash situation during summer and December futures, which represent a more plentiful ROW balance sheet. We therefore believe that cash prices for shipment until September/October will remain relatively elevated, i.e. at a strong basis to December, and will only gradually decline as new crop supplies become more abundant.

Since the futures market is a ‘discounting’ mechanism, it has already factored in a lot of bearish news lately. However, we need to remind ourselves that not only do these crops still have a long way to go, but the transition from an extremely tight supply scenario into a more ample one is going to take some time. In other words, we expect there to be a lot of pent up demand for early new crop supplies, which makes December a dangerous short if it goes much lower from here. We therefore prefer to play the bearish card in March and beyond.

Plexus Cotton Limited

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