Weekly Commodity Market Recap: Cotton

Domestic and global cotton prices trickled lower last week, burdened by weighty prospects for weaker cotton textile output in India and expectations of bulging global inventories of the fiber by the end of the next marketing year. At 87.48 cents per pound, ICE cotton futures Thursday touched their lowest so far this year before rebounding modestly Friday. Prices across every contract month retreated for the week, with several touching their lowest weekly settles so far this year. Foreign growths also joined the slide, with the ‘A’ Index tumbling 120 points Friday to a seven-week low of 98.15 cents. In China ZCE cotton futures sank across all contract months again Friday, with several reaching the lowest settles in more than six weeks. Total open interest expanded for the fifth straight session, stretching to a five-month high. The hemorrhaging also continues unabated for a range of Indian spot quotes, down sharply last week to the lowest levels this year. The widespread—if relatively modest—erosion in prices around the world last week reflects mounting bearish evidence hinting at looser balance sheets, both this marketing year and next.

Two key fundamental drivers impacting the market last week were from India and the USDA. First, early in the week came news that Indian cotton yarn production sank again in December, down -16.1% from a year earlier, the eighth straight month of double-digit year-over-year losses. This disappointing contraction in output confirmed 2011 as the worst year in at least a decade for the local cotton spinning sector. What’s more, the plunge reinforces our earlier view that cotton consumption forecasts by the USDA and India’s Cotton Advisory Board remain too generous. If these projections are whittled lower in coming months, Indian and global balance sheets for the current marketing year are likely to loosen, pointing to softer prices ahead.

The second key news for the week came from the USDA’s annual Agricultural Outlook Forum held near Washington, DC late last week. While unofficial, a tentative new-crop global balance sheet presented by USDA economists indicated world cotton production was likely to outpace mill demand for the third straight year in 2012/13. If so, ending stocks by the conclusion of the next marketing year are likely to rise, perhaps to a record 64.8 million bales. If this projected balance sheet comes to fruition, it will denote the loosest global fundamentals in eleven years, implying softer prices may lie ahead in 2012/13. Indeed, in a speech at the Forum, USDA Chief Economist Joseph Glauber expects crop prices to fall in the new marketing year, with cotton averaging 80 cents per pound. With futures presently closer to 90 cents and ‘A’ Index quotes even higher, last week’s erosion in price may be only a modest, early slip in a more protracted tumble to much lower prices later in 2012.

Weekly Commodity Market Recap: Cotton

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Cotton saw one of its most volatile periods on record last week, driven by a rush of panic buying and then panic selling as futures soared to unprecedented heights, only to tumble limit-down late in the week. Those two old market movers—fear and greed—clearly were in play last week, only on different days, it would seem. Cotton traded to new highs three different days, only to see its biggest collapse—and widest one-day range—in years by Friday. On balance, for the week the market touched record-high prices, ranged over 1,255 points, and covered an unheard-of 993 points on Friday alone.

Trading on the ICE Futures U.S. began the week with a bang, soaring limit-up on news that India had suspended registrations of cotton for export this year, only ten days after opening the registration period. Indian traders had already registered the government’s maximum of 5.5 million bales, reflecting not only soaring foreign demand but locals’ concern that the government may hinder cotton exports again in coming months.

Following Tuesday’s consolidation and an inside day Wednesday, the market was poised for another climb and test of its all-time record high Thursday. A confluence of several factors around the world helped propel U.S. cotton futures dramatically higher this day. First, cotton on China’s Zhengzhou Commodity Exchange closed limit-up on near-record open interest, following news of mills’ unusually low cotton inventories across the country. Next, news from India further fueled this bullish fire. The country’s textile sector redoubled its calls to the government to postpone cotton exports until 2011, to the panicked dismay of importing mills across Asia. Also, disappointing economic reports in the U.S. paved the way for further quantitative easing by the Fed, dragging the dollar lower and pushing commodities higher. As a result, all 2010/11 contracts closed limit-up again. Synthetic prices for December closed at 118.87 cents/lb, setting a record high in the 140-year history of the exchange.

After gapping higher on follow-though trading, the bulls lost their appetite in early Friday action and the bears ruled the day. From the intra-day high of 119.80 cents/lb—a record—the market plummeted an astounding 993 points to settle limit down at 109.87, crashing -8.3%, the largest non-synthetic daily range ever.

In spite of Friday’s tumble, cotton futures still managed to rise for the week, up for the twelfth time in the last fifteen weeks. Several factors support this string of gains to the highest weekly close in fifteen years. Unfixed call sales stand at a record level here, and many spinners still need to buy December to fix their on-call purchases. Surging U.S. export commitments detailed here remain on a record pace, despite a modest start to shipments this marketing year. And suspicions are rising here of disappointing yields in China, hinting at more imports in coming months. Not to mention, the impact from a weaker dollar and bullish specs and funds cannot be overstated. With little fundamental history to suggest a price range for the market and constrain these volatile swings, it appears these wild fluctuations may persist, reflecting the need for a comprehensive risk management strategy to protect against the market’s peaks and swoons. To learn more about how we can help you manage this risk, please click here.

Weekly Commodity Market Recap: Cotton

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Cotton rebounded impressively last week on the ICE Futures U.S., buoyed by a converging swell of different factors that lifted the market to the highest levels in years. Nearby December futures soared 915 points on the week to close Friday at 107.17 cents per pound, the highest close in more than fifteen years. The market has risen eleven of the last fourteen weeks, tacking on 37.7% in less than three and a half months, one of the steepest and biggest gains ever recorded. Every contract enjoyed the upswing last week, with several climbing to life-of-contract highs Friday. From China’s return from holiday to India’s soaring export registrations to tighter fundamentals to a weaker dollar, several issues were at play to boost cotton prices last week.

First, the siren song of soaring spot and forward markets in China helped propel global cotton prices higher. After returning from the week-long National Day holidays, Chinese traders wasted little time in driving cotton prices on the Zhengzhou Commodity Exchange limit-up late in the week. While harvest weather was favorably dry across much of the country during the break, picking remains behind schedule and mills’ appetite for the fiber remained voracious, in spite of even higher prices. Accordingly, traders were in no mood to be caught short, particularly given the rebound in ICE prices during the holiday. Every ZCE cotton contract soared late in the week with most reaching life-of-contract highs, and China’s CNCE closed limit-up two sessions in a row, helping justify the gains on the ICE.

Next, an impressive—and largely unanticipated—surge in cotton registrations in India threatens to cap this outlet for forthcoming exports, and may fan the protectionist flames further against additional shipments abroad, driving prices higher. The Indian government’s window for shippers and merchants to register new exports for later shipment is slamming shut just ten days after first opening. Since October 1st, traders already applied for export permits totaling 5.5 million bales, equaling the government’s entire export allocation for the marketing year imposed here. The surge reflects both desperately low inventories in mills across Asia and traders trying to ship as much cotton as possible, as soon as possible, both before the tax-free limit of 5.5 million bales is reached and in case the government restricts exports again. While we demonstrated here that the harvest will easily surpass domestic mills’ needs for the eighth straight year, we do not look for the government to ignore the demands from the local textile industry and raise cotton export limits soon. As we showed here, despite its best of intentions, the government’s meddling in open-market cotton trade to contain domestic prices is backfiring and helping propel both Indian and global cotton prices higher.

Additionally, the USDA added further fuel to the bullish fire in its latest WASDE report. The October balance sheet released late last week here pointed to tighter global fundamentals than earlier anticipated, helping strengthen prices further. In particular, world ending stocks were revised lower from last month’s 45.4 million-bale forecast to 44.7 million. The biggest changes came in China, where anticipated production fell one million bales to 31.5 million. Chinese beginning and ending stocks shrank and forecasted imports climbed. As a result, the world stocks-to-use ratio declined even further from last month’s 37.7% to 37.0%, the lowest in sixteen years, concurring with the highest year-to-date average prices also in sixteen years.

Finally, outside the world of cotton, the U.S. dollar continues to plumb new depths, helping to boost prices for a range of export commodities. The U.S. dollar index fell for the fourth straight week as monetary policy remains exceedingly loose, settling at 77.563 Friday, its lowest close in almost nine months. Friday’s less-than-stellar U.S. employment report exacerbated worries over the U.S. economy. And following the weekend IMF summit that failed to ease tensions over a festering international ‘currency war’, the Federal Reserve is set to provide additional stimuli to the sagging economy, which is likely to weigh on the dollar and boost commodity prices even further.

Weekly Commodity Market Recap: Cotton

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Futures trading in New York firmed again last week, driving nearby prices to the highest levels in more than fifteen years as near-term supply concerns around the globe remain a dominant issue. At 99.93 cents per pound, Friday’s finish closed out the tenth weekly increase in the last twelve weeks. In fact, earlier in the week futures gapped as high as 103.55 cents before retreating lower to finish the week up 232 points. Backwardation remains endemic in every contract through 2012. The most-active December contract is up an astounding 26 cents—or more than 36%—in just two months, reflecting both a weaker dollar and concern over shorter crops and tight supplies in a number of markets.

First, the dollar continues to sink lower, boosting export-dependent commodity prices. Dollar Index futures tumbled for the fourth time in five weeks last week, crashing through support to 79.599 Friday, the lowest close in six months. Loose, accommodative monetary policies reinforced by Federal Reserve comments again last week are sure to keep the greenback under pressure for the foreseeable future, suggesting firmer cotton prices may rule for some time.

Next, crop prospects in key markets remain tilted in a more pessimistic—rather than optimistic—direction, further supporting the bulls’ position. The latest cotton assessment in the U.S. shows crop conditions are eroding from early this summer, suggesting yield prospects may fade in tandem as we suggested here. In particular, the USDA recently declared topsoil has turned “short or very short” of moisture over a large percentage of the South. Coupled with unwelcome weekend rains over open-boll cotton in much of the area, prospects for yield and quality could dim further, supportive of price.

China’s crop also remains a concern, plagued by late plantings this spring and heavy rains this fall that are delaying the harvest. Evidence here shows every key cotton-growing region in the North China Plain is seeing cumulative precipitation this season much heavier than normal. What’s more, many of these showers have fallen in recent days, when the crop needs dry days and cool nights to reach full potential. Instead, picking is delayed and the crop in the world’s largest producer could be compromised. In response, over the weekend China announced plans to expand its reserve auction by another 400,000 metric tons to 1.0 million tons, in order to ease near-term supplies for local mills. This move did little to ease panic buying, with every ZCE futures contract month surging to life-of-contract highs.

In light of these bullish indicators, the question remains how much of this sentiment is already factored into the market. While calling a top in a runaway bull market like this is a fool’s game, we take caution that any continued tightening in the fundamentals mostly may be priced into the market already. Futures may have further to climb this fall, but we remain wary of the volatility and look for any continued tightening in the fundamentals to have a more muted impact on driving prices higher.

Weekly Commodity Market Recap: Cotton

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Following the previous week’s surge, cotton prices on the ICE Futures U.S. exchange moderated last week, posting only modest gains during trading that saw the market grapple with news that pushed prices both higher and lower. At 81.78 cents per pound, nearby prices rose a modest 24 points for the week to the highest weekly close in a month. The market remains choppy, with daily closes for the Nearby range-bound in a 700-point channel over the last four months. For the week, dominant news that worked to pull the market higher was tighter anticipated fundamentals in China in the new marketing year, while an announcement of unrestricted exports from India partially offset this bullish sentiment.

First, an early peek at a Chinese balance sheet confirms the outlook for even tighter fundamentals in the new marketing year. Here, China’s National Cotton Market Monitoring System (NCMMS) is looking for domestic mill demand to outpace domestic supplies again in 2010/11, implying already-small ending stocks will shrink further by the end of the new marketing year, providing more fundamental evidence to support higher domestic prices. While the NCMMS looks for the Chinese harvest size to expand this autumn, it still looks for mill use to easily surpass the crop size for the twelfth straight year, implying China will have to import even more cotton in coming months. This could boost export prospects for several key foreign suppliers—particularly the U.S., India, and Brazil—and is likely to tighten global supplies, driving domestic and world prices higher. Already, average nearby prices on China’s ZCE so far in 2009/10 are up 2,908 yuan/ton (19.3 cents/lb) from the previous year and stand near a record high. If the 2010/11 ratio tightens as much as projected, this would be fundamentally friendly to even higher average domestic prices in the new marketing year.

Offsetting this sentiment somewhat, we reported here an announcement from India’s Ministry of Commerce of an apparent reversal of policy from just two months ago that now allows unregistered, duty-free cotton exports to all destinations. When restrictions were first imposed in April, U.S. prices closed limit-up and gapped even higher the next day on the assumption that U.S. supplies would fill the export void left from much of the absent Indian supplies. This determination essentially reverses these restrictions, with implementation due to take effect on October 1st, roughly when new-crop supplies begin to enter the market. While the market did not post a drop on the news similar to April’s jump, the outlook for higher Indian exports in 2010/11 could cast a bearish pall over the market in coming months.

On balance, we look for prices to remain elevated, if volatile, in coming months. A new policy shift to a weaker yuan, retreating certificated stocks, and an outlook for tight global fundamentals in the coming marketing year all point to this same view. The long-term concern is that higher—not to mention volatile—fiber costs and flat or easing prices for textile and apparel goods sold at retail imply tighter margins and increased risk exposure for those along the supply chain. Click here for a no-obligation conversation on how FCStone may be able to minimize this risk exposure for you.

Weekly Commodity Market Recap: Cotton

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After rocketing ahead in February to its highest point in two years, cotton futures prices retreated last week, falling four of five trading days as the latest WASDE report from the USDA failed to impress and prices responded both to overbought technicals and mounting concerns about the economy. The Nearby finished the week at 80.47 cents per pound, off 1.96 cents from the week before. As we suspected here, the latest USDA forecasts saw global production ease, while U.S. fundamentals were little changed from the previous month, supporting our notion that global drivers would have more of an impact on the market this week than the domestic market. In fact, one could argue that the ‘news’ of a smaller global crop had already been factored into the market, as this information had been widely publicized for some time. Aside from this issue, there were few fundamental surprises in the report to drive price, allowing bearish technicals and outside influences to dictate price for the week.

Weighing negatively on the market this week were several overbought indicators and more worries about the U.S. economy. For example, as prices soared to their two-year high in early March, the RSI signaled the need for a correction. At 77.72, this indicator reached its highest level in 21 months, a few standard deviations away from its long-term 50.0 mean. Economic news last week also weighed on the market. Among other news, weekly U.S. jobless claims for February were higher than expected, and Chinese inflation rose to a sixteen-month high, hinting that tighter monetary policy may stifle rapid consumer demand there later in 2010.

But after four straight losses, prices rebounded on Friday, recouping mid-week losses. Stronger-than-expected February retail sales figures encouraged shorts to cover on Friday, in spite of sagging clothing store sales. A weaker dollar on Friday also fueled speculation of a likely improvement in relatively unimpressive U.S. export sales. Friday’s Commitment of Traders report showed the large specs adding 4,101 longs and 412 shorts to their combined futures and options position in the week ending March 9th, helping spur the improvement in price. Technically, trades formed a ‘bullish engulfing’ pattern on the Japanese candlestick charts. What’s more, Chinese futures prices rebounded Monday, with Nearby ZCE prices reaching 16,295 yuan per ton ($1.08 per pound), close to the ZCE record-high set in early January. This late-week turnaround leaves us believing the market may have found significant near-term support. The longer-term question remains as to how much global cotton acreage will expand this spring, and how much further the bulls will drive the market before bigger crop prospects come into focus this fall.

Weekly Commodity Market Recap: Cotton

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The corrective consolidation in prices extended into the latest week, as weaker cotton fundamentals, plunging Chinese prices, and lower commitments of traders data weighed on U.S. prices. The nearby March contract finished the week down a modest 36 points from the week before, at the lowest close since mid-November.

The week began with an impressive 180-point jump Monday, buoyed by a weaker dollar and sentiment for tighter global ending stocks in Tuesday’s WASDE report from the USDA. However, the optimism for higher prices sagged Tuesday, with prices falling three of the next four days following release of the WASDE report. Tuesday prices gave back most of Monday’s gains, falling 145 points. While USDA projections for U.S. fundamentals closely matched FCStone forecasts, the USDA figures for global supply and demand were more bearish than the market had anticipated. The bearishness carried over into the following day, when Wednesday prices tested the previous week’s low of 72.43, before closing at 73.43, up 64 points. The only other note of bullishness came Thursday following the release of the U.S. export sales report. At 460,726 480-lb. bales of Upland and Pima, sales climbed to a marketing-year high. Similarly, exports jumped in the latest week to 211,891 bales, the biggest volume since early October. Cotton destined for China accounted for the bulk of the surge, with weekly shipments the most in eight months. But in spite of this news, prices eased lower each of the last two days of the week, finishing at 72.08—a seven-week low—sunk by weaker Chinese prices and a stronger dollar.

Even as prices have eased from recent highs on the ICE Futures U.S. exchange, prices on China’s Zhengzhou Commodity Exchange have fallen much faster, weighing on global markets. Since peaking on January 4, the most-traded May contract is off 1,010 yuan per metric ton (6.72 cents per pound) to 15,830 yuan per ton, outpacing the 3.92-cent drop in March futures on the ICE exchange. Market open interest is well off its record peak set two weeks ago as well, falling by more than a third. The plunge both in open interest and prices on the ZCE is pulling market prices on this exchange closer into parity with U.S. futures prices, something we anticipated here.

U.S. futures also are easing lower on signals from the trade. First, reports of lower unfixed call sales from the CFTC weighed on futures prices last week. A significant net reduction took place on the mill side in unfixed on-call positions during last week's price skid, where mills fixed prices on 3,324 lots to reduce unfixed call sales to 49,548 lots. Unfixed holdings on the producer side increased a net 46 lots to 10,524. A second report from the CFTC showed funds and speculators cut cotton futures-options net longs to lowest combined total since week ended Nov. 24, trending in step with the decline in futures prices. Commercials reduced net shorts to 53.2% of open interest, down 10.7 percentage points from eight weeks earlier. Meanwhile, funds and speculators reduced their net longs by a combined 8,587 lots in cotton futures with options during the week ended last Tuesday, according to supplemental data reported by the CFTC Friday. They were net long a combined 131,333 lots, the lowest since the week ended November 24. Trend-following funds trimmed their net longs by 6,255 lots to 41,049, index funds pared theirs by 2,281 lots to 78,055 contracts, and small specs cut theirs by 80 lots to 12,299. The reduction by index funds came on the heels of earlier expectations for a fresh influx of money into the cotton market around the first of the year as a result of rebalancing and has sapped much of the market’s enthusiasm for higher prices.

As a result of the weaker global fundamentals, steep drop in Chinese prices, and unexpected declines in traders’ commitments, futures prices are well off their early-January highs. However, merchants still need to purchase more futures contracts than sell in order to even out their on-call positions, suggesting sentiment has not tilted to the bears just yet. We continue to expect prices to move sideways to higher over the next few weeks, once this correction is fully digested. But should alternative row crops remain at current levels, this divergence in prices will likely prompt a modest increase in U.S. cotton plantings in the spring, which longer term may stem the gains in cotton prices.

Weekly Commodity Market Recap: Cotton

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A barrage of bearish data weighed on cotton prices last week, dragging U.S. and Chinese markets lower into an overdue correction, consolidating and setting the stage before prices resume their gradual march higher this winter. Following a move to new highs early last week, cotton prices on the ICE Futures U.S. tumbled three of the next four days, finishing Friday at 72.44 cents per pound, the lowest level in seven weeks. Several issues together pulled prices lower on the week, including prospects for looser anticipated global fundamentals on Tuesday’s WASDE report, rumors of fund balancing, lower Chinese futures prices, and the Chinese central bank’s raising of interest rates.

First, market sentiment points to higher global cotton production forecasts when the USDA releases its next WASDE report Tuesday morning, boosting anticipated carryover stocks. Here, beneficial rains across the eastern third of Australia over the last half month continue to ease crop concerns from just a few months ago. While the crop there still needs ample moisture during the crucial February fruiting period, ample December and January showers dramatically boosted yield prospects for one of the world’s leading cotton exporters. Similarly, excellent crop conditions across much of the Brazilian cotton belt here are helping improve harvest prospects in the Southern Hemisphere’s largest producer this year. Additionally, the latest data on the robust pace of cotton arrivals in Pakistan here continue to support our long-held view that production forecasts in this market remain too conservative. Together, should these harvest sizes be revised higher as we anticipate, the increase in global supply could temper much of the near-term enthusiasm for continued price gains.

A second issue that weighed on cotton prices last week was rumors of fund rebalancing and a rebound in the dollar. According to the CFTC Commitments of Traders Report, for the week ending January 5th, index funds were net sellers of only 123 contracts, which reduced their net long position to 80,336 contracts. Hedge funds, however, were more aggressive sellers, decreasing their net long position by 4,423 contracts to stand at 41,032. But several market watchers see this as profit-taking by long-only funds, and not an indication that index funds are any less bullish.

The dollar also dragged on many commodities last week, including cotton. In the first full week of trading in the New Year, the U.S. Dollar Index rebounded to 77.655, a three-week high. But Friday’s disappointing jobs report and higher oil prices are likely to temper gains in the greenback in coming days, improving the near-term outlook for cotton.

Lastly, U.S. futures prices were heavily influenced by China’s impact on the market. Plummeting cotton prices on China’s Zhengzhou Commodity Exchange (ZCE) dragged U.S. prices lower. The most-traded May contract on the ZCE fell 570 yuan per ton last week (3.8 cents per pound) on plunging volume and open interest, the biggest weekly drop in months. The drop in futures came as The People's Bank of China Thursday raised the interest rate on its three-month treasury bills for the first time since this summer, stoking fears that Beijing could start tightening monetary policy in the coming months. Market perception is that as the Chinese attempt to gently slow economic growth and head off inflation, consumption of raw materials will slow. This policy shift reverberated across cotton markets around the world, driving prices lower.

While we acknowledge the overdue need for this corrective consolidation in prices, we continue to expect prices to continue to move sideways to higher over the next few weeks, which will likely prompt a modest increase in U.S. cotton plantings in the spring.

Weekly Commodity Market Recap: Cotton

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Cotton enjoyed another week of gains, finishing the year with its highest weekly close since the March 2008 spike. Re-strengthening global demand signals continue to support price, along with soaring trade on China’s Zhengzhou Commodity Exchange (ZCE). A firmer demand picture came into focus this last week, framed by good news in several markets. U.S. export sales of Upland cotton hit a marketing year high of 349,576 bales during the previous week, with much of these sales to China. News of another month of double-digit growth in Pakistani cotton yarn exports here suggested fabric mills across Asia are ramping up production. Likewise, Thai cotton yarn exports detailed here soared at the fastest pace in six years, echoing this sentiment. Downstream, faster growth in retail apparel sales in several markets including Taiwan, Canada, and Poland here confirms the improving prospects for cotton mill demand, as once-wary shoppers begin to return to stores in key markets around the world.

A second key driver impacting prices both in the U.S. and around the world has been the impressive performance of futures trading on China’s ZCE. Prices on the most-trade May contract stand at a record level, followed by soaring volume and open interest. As we discuss here, in just the last week, the May contract soared 835 yuan (5.55 cents per pound) to its new record, as volume more than doubled over the same short period to a record 584,560 contracts. Short supplies, transportation bottlenecks, and faster growth in mill demand for cotton are helping propel Chinese cotton futures prices to these uncharted heights, but the potential for increased cotton plantings this spring may ease price pressure in coming months.

In light of these bullish fundamentals, we look for prices to continue to move sideways to higher over the next few weeks, which will likely prompt a sizable increase in U.S. cotton plantings in the spring. Wednesday morning the market will digest the latest economic outlook from the National Cotton Council, followed by a detailed supply/demand outlook from the International Cotton Advisory Committee and comments on regulatory oversight of the cotton market from CFTC Commissioner Michael Dunn. These reports could have an impact on both trading and price action in coming weeks, and will warrant close attention.

Are ICE and ZCE Cotton Futures Poised to Strengthen Further in Second Half of 2009/10?

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After the unprecedented spike in global cotton prices witnessed in 2008 and the resultant shockwaves felt thereafter across the global cotton market, prices in 2009 returned to levels more in line with traditional influences. These drivers include factors internal and external to the cotton market, and show strong correlations to futures prices. Looking ahead to 2010, these signals suggest cotton prices are likely to remain firm, above their long-term average level, as the global economy re-accelerates from a tumultuous 2008, driving renewed growth aggregate demand for cotton textiles and apparel.

Perhaps one of the most influential drivers on global and U.S. cotton prices is fundamental analysis. The study of the ebb, flow and interaction of supply and demand yields insight into current price levels and can hint at the future direction of price. A measure of this interaction, the stocks-to-use ratio, is often strongly correlated with price. More specifically, the tighter or looser the ratio between anticipated ending stocks and expected demand changes, the higher or lower we can expect price to trend. This relationship is evident in the graph below, showing that in recent months, the forecasted stocks-to-use ratio for the U.S. cotton market has fallen, or tightened. As this has occurred, the monthly average futures price has risen in tandem, breaching 70 cents per pound over the first few days in December.

Analysis of the stocks-to-use ratio can yield important clues to the future direction of price. For example, the USDA’s November forecasted stocks-to-use ratio for the 2009/10 marketing year is 35.2%, the smallest ratio in fourteen months. Not coincidentally, November’s average prices for nearby cotton on ICE Futures U.S. were 68.73 cents per pound, the highest in fifteen months. Reports of likely changes in supply and demand can cause this anticipated ratio to rise or fall, in turn driving price lower or higher in tandem.

Looking ahead to 2010, we expect the U.S. stocks-to-use ratio to tighten further in coming months, suggesting price could strengthen even further. We base our forecast on prospects that the U.S. harvest size may be smaller than currently projected, and on the belief that U.S. exports may outpace the current target in the remaining months of this marketing year. Certainly, this bullish outlook is tempered by the notion that prices already outpace the level suggested by this historic relationship. This implies that any continued appreciation in futures prices may not be commensurate with continued declines in the stocks-to-use ratio. Regardless, we look for the market to remain firm well through winter, perhaps until attention turns to the outlook for higher cotton plantings again in the spring.

Looking more broadly across the U.S. economy, factors external to the cotton market are also having a strong influence over cotton prices. First, the weaker U.S. dollar is boosting the outlook for a host of exportable commodities, including cotton. Both the dollar and cotton prices moved in lock-step over the last two years and presently stand near levels not seen in sixteen months. The outlook for the dollar in 2010 is dependent upon myriad factors both in the U.S. and abroad, including the outlook for interest rates, capital markets, inflation, government policies, and other economic indicators. While it remains impossible to accurately forecast the value of the dollar, we, along with many other market observers, remain pessimistic on the prospects for the greenback, helping support the outlook for a range of commodity prices, including cotton.


Second, speaking of capital markets, cotton prices have had an uncanny correlation with equity prices in the U.S. recently. As darkening clouds over the U.S. economy grew more ominous in the final months of 2007, stock markets in the U.S. began a hasty retreat as investors moved money to safer investments. After peaking in October 2007, the Dow Jones Industrial Average lost more than half its value over the next year and a half, falling to its lowest level in a dozen years. Since then, the Dow has posted one of its biggest rebounds in history, soaring roughly 50% from its March 2009 low. The Dow now sits near its highest level in fourteen months. Similarly, after spiking to the highest level in years in early 2008, cotton futures prices plunged more than 60% over the next eight months to 39.14 cents per pound, the lowest level in more than six years. Since then, nearby cotton prices have steadily climbed, surpassing 70 cents for the first time in sixteen months. Similar to gauging the value of the dollar, forecasting stock prices naturally is next to impossible. But many analysts agree that the impressive jump in the Dow in 2009 is unlikely to be duplicated in 2010, suggesting that any continued re-strengthening in cotton prices is likely to come at a slower rate than witnessed this year.
Aside from fluctuations in cotton supply and demand and factors external to the cotton market, the sales of merchants and positions of large traders and funds in the market continue to be strongly correlated to cotton prices. Week-to-week on-call sales across all contract months continue their co-movement with nearby cotton futures over the last two years. In fact, less than two months ago unfixed call sales reached 54,135 contracts—their highest level in fourteen months—at the same time that weekly nearby prices surpassed 68 cents, the highest level in sixteen months. In the weeks since, a gap opened between the two measures. But we look for this divergence to narrow in coming months, whether in the form of lower cotton prices or higher unfixed call sales. Given the bullish other factors noted earlier, we are more confident that unfixed call sales will slowly expand to fill that gap.


The role of hedge and index funds is likely to remain integral to commodity prices—including cotton—well into 2010. The increasing prevalence of long-only commodity indexes and the increasing acceptance of commodities as an asset class are helping drive interest—and therefore volume—in this area, boosting prices. Likewise, the prominence of agricultural commodities in these indexes has substantially increased in recent years. The cotton market has enjoyed a relatively consistent share of the surge of index and hedge fund monies into the market over the last two years, supporting price. In fact, for well over two years, the ebb and flow of index funds’ net positions have mirrored the rise and fall of cotton prices. Just as the net position of index funds is hovering near a fourteen-month high, so too are cotton prices. Looking ahead, aside from political wrangling over new bills governing increased transparency for some larger market participants, we see little reason to expect the inflow of hedge and index funds to ease in 2010, supporting an outlook for robust price in the months ahead.

Lastly, we turn away from the U.S. futures market to the impressive performance of cotton on the Zhengzhou Commodity Exchange. Since commencing trading on the ZCE over five years ago, cotton futures prices have trended in step with their American counterparts, reflecting efficient market-clearing and price-discovery mechanisms in place in both markets. Clearly, the issues that impact price in one market are felt half a world away, driving price in the other market.

This relationship has been particularly evident over the last year, when prices on both the ICE Futures U.S. and the ZCE exchanges reached near-term lows on virtually the same day. Since then, nearby prices on both exchanges have risen in step with one another to the highest levels in roughly fourteen months. It is only over the last month that ZCE cotton prices continued to climb, far outpacing gains on the ICE and peaking recently at record levels just as market volume also soared to more than 500,000 contracts, also a record. This surge in price easily outpaces gains in downstream intermediate yarns and fabrics and appears inherently inflationary—and therefore unsustainable. While we are optimistic on the prospects for continued strength in global cotton prices into 2010, we are not as confident ZCE prices will be able to maintain such a premium. We expect that any continued gains in ICE futures prices are unlikely to be met with commensurate increases in ZCE prices. And should this sudden spike in ZCE volume and open interest suddenly plunge, we would expect Nearby prices in China to retreat closer in line with U.S. futures prices in coming months.