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

Cotton prices crept higher last week, as concern over the outlook for yield and quality of the Mid-South crop outweighed bearish influences from outside markets. As we feared here, the month concluded as the wettest October in over a century for much of the Delta area planted to cotton, causing the most delayed harvest on record. Additionally, the drenching showers in Delta cropland is impacting quality of the crop, ranging from boll rot and yellowing of the cotton fibers to lower average strength detailed here. While producers in the region are likely to rapidly advance picking under clear skies in the coming week, the damage has been done; the next USDA crop report in a week is likely to show a dramatic drop in the size of the Mid-South cotton harvest, buoying cotton prices.

In the shorter term, price action is likely to remain choppy, as the market ebbs and flows between good and bad news on the economy. Traders were quick to dismiss Thursday’s news of robust expansion in third-quarter U.S. economic activity, after Friday’s disappointing spending data and considering the skewed effect from government spending and one-time stimulus measures in the housing and auto sectors. On balance, the dollar is solidly up from its fourteen-month low set a week ago, hindering continued gains across a wide range of commodities, including cotton.

Total open interest has been on a tear recently, expanding to over 185,000 contracts by late October, the highest in over a year. Not coincidentally, this comes as nearby cotton futures finished last week at their highest weekly close in fifteen months. Even so, speculators widely believe cotton is undervalued, and torrential, record rains across U.S. Delta cotton is compounding speculator resolve. Technical traders see rising prices and open interest and believe another push up is coming. While open interest is at its highest level since October 2008, we note that market open interest stayed above current levels for twenty months prior to last October, suggesting the market may have much longer to persist at or above these levels.