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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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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Cotton futures climbed for seven of the last eight weeks to settle Friday at the highest weekly close in almost fifteen years, driven by a combination of bullish issues. Intraday nearby futures prices pierced 90 cents per pound Friday for the first time in almost two and a half years before finishing the week at 89.03 cents, the highest since September 1995. Most of the market’s support is due to supply-side concerns, ranging from the extent of damage from Pakistani flooding to drier conditions across much of the U.S. cotton belt to the record volume of on-call sales still waiting to be fixed.

First, as floodwaters begin to slowly recede across much of Pakistan, estimates of crop damage are beginning to come more into focus. While rice appears to receive the worst impact, the domestic cotton crop was inundated. Pakistan’s Ministry of Food and Agriculture estimates 15% of the harvest will be lost, reducing the cotton crop in the world’s fourth-largest producer to less than 9.2 million bales. What’s more, the Pakistan Meteorological Department still is reporting exceptionally heavy flooding in southern parts of Sindh, hinting that loss estimates could expand even further once observers get a clearer picture of the remaining crop when these floodwaters finally recede.

Anxious Pakistani mills are turning away from the flooded domestic crop to neighboring India to ensure a steady supply of cotton in coming months. As a result, Indian markets are firm with high demand and already-tight supply, propelling local prices even higher. In another flip/flop of policy, India is considering re-imposing an export quota and restrictive duty on new-crop cotton shipped abroad starting in October. Before it was removed earlier this summer here, the export duty was Rs. 2,500 per metric ton (2.4 cents/lb), but rumors are circulating that it may rise to Rs. 10,000 at the request of the domestic textile industry. These on-again, off-again restrictions are exasperating local exporters and foreign mills concerned over forward deals that have already been committed. In fact, almost 700,000 bales already are contracted to Pakistani buyers facing a big shortage in their crop caused by the worst flooding in decades, adding to mounting consternation and risk exposure for local buyers and sellers.

In the U.S., dry cotton areas in the Midsouth and parts of Texas are likely to see little chance for cool, moist relief in coming days, adding to concerns over mounting stress on the crop. As we discussed here, meteorologists look for a return of late-season heat across the eastern half of the cotton belt in September, owing to the Pacific La Niña. Combined with longer-term forecasts for drier conditions to persist across the Delta, the area is likely to stay abnormally hot and dry through harvest. Accordingly, while yields across the country still are likely to climb from last year, the outlook for the size of the crop is not as robust as just a few weeks ago, adding further bullish sentiment to the market.

A last issue that warrants attention is the influence of specs and the trade on the market. First, at 91,389 contracts, last week’s record amount of unfixed call sales implies there is an impressive volume for export waiting to fix prices on any market dips. What’s more, speculators added to their net long position again for the fourth straight week while the trade got shorter on increasing total open interest, trends that have helped buoy cotton futures over the same period. While there is no question that demand remains robust and supply concerns are mounting, we caution that when things look this bullish, it’s time to be careful.