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.

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.

Weekly Commodity Market Recap: Cotton

After rising each of the previous three weeks, cotton futures retreated last week on weaker outside influences, fund selling, better harvest weather, and bearish technical signals. After cresting at the highest level in more than a year, nearby prices dropped 124 points on the week to 61.94 cents per pound, pulled lower by Friday’s nearly limit-down close. The broader commodity complex saw general weakness over recent days, as the CRB Index eased lower for the week. This broad-based weakness weighed on cotton prices as the dollar posted a modest recovery last week. After falling to a 13-month low, the U.S. Dollar Index rebounded late in the week to a three-week high before settling at 77.02, up 35 points on the week. Also, confirming the relationship we showed here, weaker equities took a toll on the cotton market. After climbing to its highest level in almost a year, the Dow Jones Industrial Average slipped last week, dragging cotton prices lower. Weaker commodity prices, a stronger dollar, and lower stock prices together cast a pall over the cotton market, helping drag every contract month for the next two years lower for the week.

Fund selling also contributed to weigh on cotton prices last week. Mirroring the rise in cotton prices over the last year, index funds’ net position rose to 75,219 contracts a week ago, the highest in twelve months. This left the market vulnerable to a setback that we suggested here. Accordingly, last week’s fund selling drove this net position lower to 74,741, prompting the exit in the market late in the week.

Weather has turned much more favorable across the U.S. cotton belt in recent days, improving the yield outlook from earlier in September. While the Delta and areas of the Southeast received heavy rains over the previous two weeks here, conditions turned drier this weekend and are expected to remain mostly dry for the week. The forecast for the next few days here has the Delta and Southeast warming up and drying out, which should promote boll opening and early harvesting. In West Texas, warmer, sunny conditions will prevail this week. While the recent deluge in rains slowed the development and harvesting of the crop, the warmer, dry days this week will be welcome across the Belt.

Weaker technicals also pressured cotton prices lower on the week. By climbing to a new high only to falter to a low by the end of the week sets up a bearish outside range reversal to the downside and hints at additional selling early this week. A hook reversal late in the week added to the bearish sentiment. And after signaling overbought conditions by breaching the critical 70-level on the RSI late the week before, lower prices reduced this indicator to a more moderate range. The market has been due for a correction, and last week's activity seemed to show just that.