Latest collapse in cotton prices depressing

20 Apr '07

5 min read

Over the last four weeks, the US has sold almost 2 million bales for export, with 25 markets participating in the buying, and with China booking around 1.1 mio bales. Furthermore, almost all of these sales were for shipment between April and July, with not much being sold for August onward at this juncture. Since China and most other markets are still wide open between August and October, it is almost a given that we shall see a decent amount of demand for US cotton all the way to new crop.

Why is the futures market behaving so poorly with all this encouraging news on the export front? We believe that it was caused by a combination of two factors. The first one was the deteriorating technical picture, which attracted new spec shorts once important support levels were broken.

The second one was of fundamental nature, as the huge certificated stock of currently around 700'000 bales needed to find a level at which it would more or less be at par with cash cotton. In other words, cotton in the certificated stock cannot be more valuable than cotton in the cash market, since otherwise no one is willing to carry this huge block of inventory.

However, with May at around 49.00 cents, we believe that the certificated stock is now cheap enough to find a taker, unless the AWP unexpectedly starts to decline again, which would open the door for prices to erode further. But since we are now officially in the AWP blending period, there will sooner or later be an upward adjustment to forward quotes, which should lift the AWP in relation to spot futures.

Even though speculators have the power to push the market even lower in the interim, prices will ultimately have to reflect what makes sense from a fundamental point of view. Since March 29th, the May contract has dropped by over 500 points, while the AWP has given up just 113 points during the same time frame. What we need to remember is that US prices start their price calculation with the AWP, because that's the level at which the 10.2 mio bales that remain in the loan can be redeemed from the government. Therefore, unless we see the AWP drop from here, the shorts may find themselves in a predicament if they keep pressing the downside.

Plexus Cotton

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