NY cotton futures display mixed reactions this week

The US is the residual supplier to the world, with nearly its entire crop available for export. Theoretically the US has an exportable surplus of 13.5 million bales next season (17.0 million bales crop versus mill us of 3.5 million bales), but the USDA believes that only 11.8 million bales will ultimately be exported. When we look at the world minus China and the US, we have production at 67.8 million bales and mill use at 65.5 million bales, resulting in a small surplus of 2.3 million bales.

This may seem comfortable, but since China is expected to import 4.0 million bales more than its actual shortfall and the US is believed to export 1.7 million bales less than it could, the situation may actually turn out to be a lot tighter than it appears.

We keep hearing and reading the argument that the new crop prices won’t be able to rally, because China would be there to unload its excess stocks and quickly cap any rally attempt. While this argument seems to make a lot of sense at first, it really doesn’t hold much water since it is highly unlikely that China would release any of its Reserve stocks.

Or do we really think that if NY futures were to rally to 80 or 90 cents, the Chinese Reserve would unload inventory that it accumulated at 140 cents? For Reserve stocks to be released, Chinese domestic prices would first have to rise to a level well in excess of 140 cents.

Only if that were to happen it would eventually put pressure on international prices, as the release of Reserve stocks would likely lead to fewer imports. 

From a Chinese perspective the NY futures market at 70 cents must look like an incredible bargain, which means that given the opportunity, Chinese traders and mills will continue to import as much cotton as they possibly can, be it in the form of raw cotton or converted to yarn.

Just look at today’s stellar US export sales report, which fits right into this scenario. Between September 2011 and May 2012, China has already imported 19.5 million statistical bales, which makes it very likely that the revised USDA estimate of 23.25 million bales will either be met or surpassed.

Also, as pointed out earlier, we feel that the current statistics are not accurately reflecting the impact of the recent shift towards yarn imports. While it makes sense for Chinese mills to use less cotton due to the huge price gap in relation to the international market, we feel that mill consumption in other parts of the world is picking up at least some of the slack.

In other words, while Chinese mill use may have fallen from 50 million to 40 million bales over the last three seasons, this should not be counted as a net loss in global consumption.