Weekly Commodity Market Recap: Cotton

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In anticipation of the USDA’s next release in coming days of the latest U.S. cotton supply and demand projections for new-crop cotton, FCStone prepared forecasts and commentary on how these projections may change from recent months:

U.S. production for 2010-2011: Down 300,000 bales to 18.5 million bales. While yields are still likely to be well above last year, crop conditions generally have eased gradually over the last two months across much of the cotton belt, suggesting yields may not be as robust as earlier anticipated. While this trend is happening in several states, we are keeping a close eye on Texas and the Carolinas. Here, the northeastern corner of the cotton belt received well over eight inches of rain last week, drenching open-boll cotton and fading harvest prospects. Also, the condition of the Texas crop still in the field has eroded to the lowest since June, dimming earlier optimism somewhat.

U.S. Exports: Up for the fourth straight month, rising from 15.5 million to 15.7 million bales. Already, early-season commitments stand at a record 8.9 million running bales, hinting at robust exports later this marketing year. Adverse pre-harvest weather in several cotton-growing areas of China was unwelcome and may hinder production and quality, suggesting the world’s largest importer may need to import even more fiber in 2010/11, with much of that coming from the U.S. What’s more, delayed exports from India discussed here also could bode well for shippers in the U.S. and Australia this marketing year.

U.S. Ending Stocks: With a likely smaller anticipated supply and projected demand bigger from last month, ending stock forecasts for October are likely lower by 500,000 bales from September to 2.2 million bales, the lowest level in more than five decades. Unsurprisingly, recent daily closes on The ICE here touched the highest levels in years in response. We look for the USDA to find expectations of higher demand and lower ending stocks will tighten the anticipated stocks-to-use ratio this year to closer to 14%. This would be the tightest ratio since 1994/95—the last time average prices were as high—and supportive of elevated prices well into the winter.

In spite of this increasingly tighter outlook for U.S. cotton fundamentals, we caution that any increase in U.S. prices may not be commensurate with the tightening in the balance sheet, as it has been over recent months. As the graph below demonstrates, the jump in futures prices has outpaced the tightening in the stocks-to-use ratio over the last two months. And October’s anticipated 12% ratio—while tighter than any point in years—still is not tight enough to support average September prices, let alone even higher prices in October. This extrapolation brings with it the pitfalls inherent in any extrapolation; we caution that October prices even could slide modestly lower, despite the tighter outlook for the domestic market.

While the anticipated tighter evolution of domestic fundamentals is impressive, we temper this outlook with a forecast for looser global balance sheet. In particular, we look for the Indian harvest to jump to a record size, on the strength of unprecedented yields. That having been said, it may be a few months before Indian policymakers allow new-crop shipments to resume, suggesting global exports—and world prices—may remain dear through the conclusion of harvest.

Weekly Commodity Market Recap: Cotton

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Nearby cotton futures surged last week to a fifteen-year high at 97.61 cents/lb, closing up 674 points, the second-biggest weekly leap in more than two and a half years. The latest jump extends a trend witnessed over the last six months, and especially over recent weeks. Friday’s finish closed out the ninth weekly increase in the last eleven weeks. The most-active December contract is up an astounding 25 cents in less than two months, reflecting both a weaker dollar and near-term supply concerns for the crop.

The U.S. Dollar Index retreated late in the week to its lowest since early August and soon could fall to the lowest in more than a year and a half, depending on Fed Reserve actions later this week. While the Fed isn't likely Tuesday to change its assessment of the U.S. economy or indicate a fresh round of asset purchases, there is an outside chance it could engage in a new round of stimulation, which would further weigh on the dollar and could boost export-dependent commodity prices further.

On the supply side, the market continues to fret over inclement weather impacting much of the Indian and Chinese crops. After a late start to the season, India’s monsoon is threatening to overstay its welcome. For fifteen of the last sixteen days, widespread showers across the country have outpaced daily norms, prompting speculation the harvest size may be smaller—or at least later—than forecast if monsoon rains last longer than normal. Already, the Confederation of Indian Textile Industries is calling for the government to delay cotton exports from October to January. Naturally, a postponement from the world’s second-largest exporter could drive global prices higher as importers scramble, but even the threat of more policy meddling is boosting prices.

In China, foul weather similarly is delaying the crop and may whittle back the harvest size. By late last week, only 5% of the nationwide crop was picked, well behind the 13.6% pace averaged over recent years. And cooler, rainy weather last week in key provinces did little to hasten the harvest, increasing the risk that wintry weather could compromise yields and quality in coming weeks. What’s more, daily offtake of reserve auction supplies has expanded to more than 20,000 tons each of the last eight sessions, supporting our view here that these supplies may expire before ample new-crop volumes enter the market. In response, spot and forward prices in China continued to advance. CNCE, ZCE and physical prices posted strong gains, with every ZCE cotton contract climbing to life-of-contract highs.

The tightest global fundamentals in fifteen years are supporting the highest global cotton prices also since the mid-1990s, with little opportunity for supply-side pressures to ease in the months to come. The ‘A’ Index breached $1.00 per pound recently, while Nearby prices in the U.S. also are on the cusp of closing above one dollar for the first time in years. What’s more, looking to the conclusion of the northern hemisphere harvest, crop concerns could materialize in spots other than China and India, further propelling the market higher. So while specs continue to pile into the boat for easy sailing today, it will pay to cast an eye to the horizon in 2011 for any tumultuous waterfalls ahead.

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 Recap: Cotton

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After retreating for nine straight sessions, the cotton market came roaring back last week, with nearby prices staging a weekly reversal to the upside and closing higher for four straight days before finishing the week at 81.54 cents per pound, the highest weekly close since mid-May. For the week, the July contract gained 448 points, October rose 384 points, December tacked on 366 points, and March climbed 351 points. One key factor driving prices higher has been a pronounced contraction in certificated stocks. Since reaching the highest level in a year and a half in early June, cert stocks have fallen six of the last seven trading sessions, shrinking by more than a fourth since then. A surge of more than 624,000 bales in old-crop sales—mostly to China—confirmed where most of these decerts are going. And with May Chinese cotton imports jumping another 30.6% from last year to more than 900,000 bales, Chinese mills’ voracious appetite for foreign cotton remains evident. We look for more decerts and firmer prices into the July notice period, with the outlook leaning more bullish in coming weeks.

Longer term, crop prospects are improving in several markets, suggesting the autumn harvest in the northern hemisphere may be bigger than currently anticipated and could weigh on prices later this year. Many analysts—including FCStone—agree that timely plantings and favorable weather could boost the U.S. harvest well above the 16.7 million bales currently anticipated by the USDA. In particular, the overall West Texas crop is off to one of its best starts in years, hinting at a more optimistic yield outlook—and presumably a bigger cushion of exportable supplies—for the world’s largest cotton exporter.

Similarly, monsoon activity is accelerating and intensifying across much of India, helping advance cotton plantings. After getting off to a slower-than-normal start, the monsoon has advanced northward rapidly in recent days. Additionally, evidence here shows energy available to the monsoon is spiking well above average and indeed rains last week were well above model expectations. As a result, cotton and groundnuts are expected to see a steady and timely upturn in planting over the next week, boosting early optimism for the crop in a country that devotes more land to cotton than any other.

On balance, this view supports an outlook friendlier to the shorter-term bull, and perhaps less friendly to the longer-term bear. Global cotton supplies are likely to remain tight until new crop offers come on the market this fall. But even then, a larger world harvest still is likely to fall short of global mill demand for cotton for the fifth straight year, albeit not as much as this marketing year. Regardless, this forecast implies global ending stocks in the coming 2010/11 marketing year could fall to the lowest in years, driving the stocks-to-use ratio to the tightest since 1994/95, when world prices averaged over 90 cents per pound.