Weekly Commodity Market Recap: Cotton

Last week saw ICE cotton futures jump to their highest weekly close in two months, propelled in part by a weaker dollar and tentative prospects of improving downstream demand. Nearby futures leapt 389 points for the week to settle Friday at 93.52 cents/pound, the biggest weekly advance since the start of the year. While futures sagged only modestly Thursday and Friday, this softness did snap a streak of six gradually higher closes for the market.

Some of last week’s firmer prices rested on more signs pointing to pockets of improving demand across the global textile supply chain. While the market remains a long way from shaking off the full impact of the global destruction of demand that has gripped the supply chain the last few years, green shoots of improving demand suggest a return to modest growth may be close at hand. Most recently, Chinese cotton yarn imports benefitted from higher demand and lower unit costs to expand to a record high in February. Also last week came improving indicators of faster growth in 2012 retail demand for the largest markets in both Europe and Latin America. If these signals take root and spread, global mill demand for cotton may rebound in 2012 as well. Additionally, weekly U.S. cotton exports continue to outpace the average volume needed to reach the USDA’s forecast of 11.0 million bales, suggesting this target may be revised higher soon. Traders’ positions reflect this creeping optimism, as the weekly CFTC report showed Managed Money went from a net short position of over 10,000 contracts the previous week to a net short of just 948 contracts as of last Tuesday.

But partially offsetting some of this enthusiasm is a handful of bearish indicators. First, after touching a seven-week high Wednesday, futures retreated Thursday and Friday, in part owing to a bigger-than-expected Prospective Plantings report from the USDA. The area sown to cotton in the U.S. this spring is expected to reach 13.2 million acres. While this area is 11% less than last year, it is more acreage than many expected, hinting the harvest size may be somewhat bigger than first anticipated, assuming trend yields and abandonment. Additionally, while there are glimmers of hope for Thailand’s beleaguered fiber and textile supply chain later this year, the industry continues to reel from dull demand and last year’s record flooding. And other disappointing signs hint the Spanish apparel market—one of the five biggest in Europe—may go from bad to worse later this year. But perhaps the biggest weight to loom over the market may be the recent suspension of China’s cotton reserve procurement program. This effort effectively propped up Chinese—and by extension, global—cotton prices over recent months. But with no more procurement until the new harvest arrives, the near-record divergence between Chinese and foreign cotton prices may narrow, perhaps with Chinese prices easing to close the gap. Following Wednesday’s near-term high, cotton prices have stalled and there is little sign that demand is rising to meet the market. In fact, commercial traders report little inquiry in the aftermath of the recent rally. The fallout of no more Chinese Reserve purchases may color the market until more attention turns to weather developments as Northern Hemisphere plantings soon commence in earnest.

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.

Weekly Commodity Market Recap: Cotton

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The ebb and flow of the cotton market turned decidedly in the direction of the bulls last week, with several indicators helping prices advance. Cotton broke out of its horizontal trading range established over the last two months, primarily driven higher by a surprise announcement here that India would suspend registrations and exports of cotton for the time being, effective immediately. Responding to the steep increase in local cotton prices, India’s Office of the Textile Commissioner took this unusual move in order to boost domestic supplies and presumably temper the recent gains in local prices. Ironically, this action is likely to deplete already-short stocks of exportable supplies in the rest of the world, driving global prices higher. In response, Nearby prices on the ICE Futures U.S. exchange gapped higher on the news, surging 619 points on the week to close Friday at 86.20 cents per pound, the highest weekly close in fourteen years. Similarly, the Cotlook ‘A’ Index, a proxy for global prices, soared in step to 91.30 last week, the highest level also since the mid-1990s, reflecting higher prices worldwide for cotton.

Also bullish for price was news of a spurt in weekly exports of U.S. cotton here. Shipments climbed past 350,000 bales for the first time this marketing year, reflecting strong growth to a number of key markets. In particular, cotton destined for Chinese and Bangladeshi mills rose to the highest volume so far this marketing year. With rumors circulating that China is set to increase its tariff rate quota again soon coupled with news that India likely will not be nearly as large a competitor in coming weeks, U.S. cotton stands a strong chance of surging to China in the remainder of this marketing year. Also, forecasts for record mill demand and imports of cotton in Bangladesh suggest U.S. cotton may fare well this year as well. On balance, we look for U.S. cotton exports to follow their normal seasonal trend of accelerating in the remaining weeks of the marketing year, with mounting evidence suggesting shipments in 2009/10 could exceed the latest USDA forecast of 12.0 million bales as we first suggested here.

Although market fundamentals point to higher cotton prices, last week’s spurt may have driven the market into overbought territory—especially if the credit situation in Greece causes speculators to lighten up on risk. In the past four decades, there have only been five price moves above 90 cents per pound, and as cotton prices begin to approach this psychologically important level, the market may find willing sellers, as weak longs and commercial traders try to lock-in relatively high historic prices. The most recent Commitment of Traders report shows commercial traders increasing their net-short cotton position by nearly 11,500 contracts as of April 13th. This was before India’s announced export ban, as well as before prices moved above the consolidation range established over the last two months. Next week’s report will be interesting to see if commercials continued to sell into the rally, or if speculative accounts, mainly trend-following funds, were adding to their long positions on the chart breakout. One thing that appears evident is that cotton traders should have an interesting trading environment well into 2010, and that risk exposure for both producers and consumers is likely to be more pronounced than in recent memory.