Weekly Commodity Market Recap: Cotton

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The cotton market remains in a world all its own, shrugging off this year’s tepid performance in the broader commodity complex and soaring to the highest levels in years. ICE cotton futures last week closed up for the eighth time in the last nine weeks, breaching 90 cents per pound to finish Friday at the highest close in fifteen years. Hints at increased Chinese demand for foreign cotton, a weaker U.S. dollar, and projected tighter domestic fundamentals are helping spur prices even higher, with little opportunity for a major retrenchment on the horizon.

First, sentiment is spreading that Chinese mills may boost cotton imports in coming months, as unseasonably cool temperatures and rain dampen prospects for crop quality and output. Already, the USDA is pegging imports into China—the world’s largest mill consumer and importer—at 12.5 million bales this marketing year, the second-highest level on record. Now, late-season precipitation on open-boll cotton in key provinces may erode harvest projections, causing mills hungry for the fiber to look abroad for supplies, adding more pressure to global prices. What’s more, evidence here suggests the government’s reserve auction supplies may be depleted by early October, before abundant new-crop supplies arrive on the market. The initial 600,000 metric-ton auction has dwindled by half over the last few weeks, hinting at a squeeze on near-term supplies in coming weeks before recently harvested cotton arrives on the market later this autumn.

Next, the weaker dollar also is helping propel cotton prices higher, auguring well for the export outlook this marketing year. The greenback continues to plumb a fifteen-year low against Japan’s yen, easing importers' cost of dollar-denominated cotton. Already, export commitments are at record highs for this point in the marketing year, with widespread demand up from several key U.S. markets. At 15.0 million bales, the USDA export target for 2010/11 is up 1.5 million bales from earlier this spring. Even so, we continue to find this forecast too conservative and look for it to climb further in coming months, boding well for higher prices.

Last, in spite of the dramatic tightening of U.S. cotton fundamentals over the last year and a half, we look for the market to tighten even further, supporting elevated prices. In our latest analysis here of how the USDA may adjust its September forecasts, we anticipate the demand side of the U.S. balance sheet may expand further, with both projected exports and mill use likely to rise. As a result, ending stocks for this marketing year may decline, pushing the stocks-to-use ratio even lower to the tightest level in fifteen years, fundamentally supporting the highest prices also in fifteen years.

What’s more, other signals support the bulls’ argument. Trend-following funds last week raised their net-long cotton futures/options position to the largest since March 2008. And the latest cotton on call position report discussed here shows record-high unfixed call sales helping drive futures higher. Amid all this bullishness, the contrarian in us points to widespread overbought technical indicators that are calling for a correction. But woe be the market watcher—or participant—that calls a top and risks being gored on a runaway bull market.