NY cotton futures rally this week on short covering

31 Mar '12

5 min read

Plexus Cotton Limited reported that New York (NY) futures rallied this week on short covering, as May gained 396 points to close at 93.54 cents, while December advanced 177 points to close at 90.72 cents.

In a little over two weeks the May/Dec spread has gone from 179 points carry to an inversion of 282 points at today's close, a swing nearly 500 points! This is due to tightening supplies for nearby shipment, after China has been aggressively restocking all season long, while new crop still promises to produce more cotton than there is demand for it.

Although there is no shortage of cotton when we look at the global balance sheet, the problem is accessibility. Despite reports of a struggling textile industry in China, imports of cotton and yarn have been rather brisk in recent months, which has led to a tightening of supplies in many origins, most notably in the US and India.

The Chinese government has sidelined over 14 million bales of high priced domestic cotton through its auction system this season, while at the same time opening its doors to cheaper imports. We believe that China has been using these measures in an effort to balance the needs of farmers and mills.

The high domestic price should ensure that not too many farmers will walk away from cotton this spring, while relatively cheap imports of cotton and yarn should allow mills who export finished goods to remain competitive, although the high duty structure poses a big obstacle in that endeavor.

Since only about two-thirds of Chinese cotton products are sold domestically, mills that manufacture textile products for export cannot afford to pay substantially more for cotton than their counterparts overseas, especially in an environment of rising wages and energy prices.

More and more mills are getting squeezed and a number of companies have already gone out of business over the last twelve months. However, while Chinese mills are struggling, other markets such as Vietnam and Cambodia seem to be picking up the slack.

China's current strategy of absorbing expensive domestic cotton into its strategic reserve while allowing cheaper imports to replace it is not a sustainable model in our opinion, because it raises stocks to unmanageable levels over time.

This season China is expected to import nearly twice as many bales (18.5 million) as it needs based on a production deficit of 10.0 million bales. We feel that over the coming years China won't be able to add much more to its stockpile and that imports will therefore be limited to the size of the annual production shortfall.

In other words, there may soon be an abrupt end to the fierce Chinese buying we have become so accustomed to since last fall. Not only is the auction program going to end this week, but we also feel that most of the import quotas have been filled by now and that the release of additional quotas is unlikely. Once China turns quiet, so will the cotton market, although it is still possible that current crop futures will go out with a bang due to the many spec and trade shorts that remain in May and July.

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