NY futures continue to climb higher this week

02 Oct '10

6 min read

But let's not forget that nearly all of this cotton that has been contracted so feverishly at these elevated prices has yet to be ginned, shipped, spun, turned into textiles and sold to consumers. In a way the tail seems to be wagging the dog, because these high prices may lead to substantial demand rationing and thereby preempt the expected shortage at the end of the season.

If prices remain high enough to lead to rationing and substitution down the road, we wouldn't be surprised to see a drop in mill use of some 5-8% over the course of the season. In China, where cotton prices have rallied beyond 150 cents/lb this week, they are now nearly twice as expensive as polyester staple fiber. This is simply too much of an incentive to ignore! We are already getting anecdotal evidence from several Asian markets that mills are either trying to shift into finer counts or that they are adjusting their blends in favor of man-made fibers.

At the same time these high prices are attracting additional acres into production, starting with the Southern Hemisphere crops that are about to be planted. Both Brazil and Australia are showing a lot of enthusiasm for cotton at the moment and we expect their planted acreage to increase beyond current expectations. The same is likely going to happen in the Northern Hemisphere next spring if the market remains strong.

In other words, global production numbers may start to trend higher, while world mill use is likely headed in the other direction. The latest USDA supply/demand estimate has world output at 117.0 million bales, while mill use is at 120.5 million, but it doesn't take that much of a change to see these numbers reverse. For example, if world production were to go up by just 3%, while demand declined by 3%, we would go from a 3.5 million bales deficit to a 3.5 million bales surplus.

However, while the market is currently doing its job to correct the seasonal output gap that has existed for the past five seasons, it will probably take more than one season to rebuild stocks to a more comfortable stocks-to-use ratio. First of all, we believe that global beginning stocks were a lot lower than the 47.0 million bales the USDA has in its balance sheet, mainly because we feel that China didn't have 18.8 million bales on August 1.

The real stock number for China is probably closer to 14 million bales, which would bring global beginning stocks down to around 42 million bales. This would explain why the market has been acting like it was running out of cotton lately. In order to bring the market back into a more balanced position, stocks would probably have to rise back above 50 million bales.

So where do we go from here? We still feel that once the crop is in, the market will start to settle down into a trading range - somewhere between the low 90's and low 100's - while volatility drops and intra-crop carrying charges make a comeback. Although the upside may be limited for reasons outlined above, we also believe that there is going to be tremendous support underneath the market.

China's government has just released another 400'000 tons of its reserve, which means that it will have to start refilling these stocks the next chance it gets. This should put a strong bid under the market for the remainder of the season, along with the 10.6 million bales that mills still need to fix.

Plexus Cotton Limited

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