Cotton prices have been moving mostly sideways since February (Chart 1). The spread between old and new crop months has been typically volatile (Chart 2). The market is groping for direction.
On the one hand it is tempting to treat cotton like a bear market. With a looming recession in most of Europe and a waning recovery in the US, making a bullish case for an industrial commodity is a challenge. China, however, has been an active importer, shoring up its reserves. The April USDA crop report raised the estimate for 2011-12 Chinese imports by 2 million bales from the March estimate, to 20.5 million bales. That’s up from 12 million bales in the 2010-11 marketing year.
The estimate for US exports was raised in the crop report, by 400,000 bales, to 11.4 million bales. Old-crop sales have been dwindling, and we’ve even seen some light cancellations. The light volume, however, was mitigated by the most recent weekly export report, which showed 144,000 bales of commitments, most of which went to China. With three months remaining in the 2011-12 marketing year we need to average only about 25,000 bales of new sales per week to meet the USDA target. Over the past four weeks, shipments averaged 281,000 bales, which is inline with the 240,000 bales per week necessary to meet the target.
The decent showing of US exports is impressive, particularly in light of the fact that India has exported 20% to 25% more cotton than in a typical year. The Indian government has been weaving in and out of an export ban, but either way, the mere fact that there are customers eager to buy is an indication that demand is robust.
After accounting for the revisions contained in the April crop report, the balance sheet indeed presents a very bearish picture. The estimate for global ending stocks was increased by close to 4 million bales, to 66.07 million bales, or a staggering 61.32% of usage, up from the March estimate of 57.32%. That compares with an average carryover of 50.5% of consumption over the past decade.
A significant part of the increase in the forecast for global ending stocks was a 3-million-bale jump in the estimate for Chinese ending stocks and a 1-million-bale drop in the estimate for Chinese domestic mill consumption. All of which means that although Chinese imports have increased dramatically, it doesn’t necessarily mean that actual usage is up. However, as one well regarded analyst pointed out, the cotton that China purchased is not mobile. It was acquired to bolster reserves, and it will either be used by mills or it will just sit there. Either way, it is not available for world trade. The burdensome inventory level portrayed in the official balance sheets are somewhat of misnomer.
The spurt of Chinese stockpiling will come to a halt eventually – when the central planners reach their goal. Looking past that day, we still find that the outlook is not quite that bearish. In planning for 2012-13 crops, we find that farmers are assuming that there will be little growth in overall consumption. The March 30 planting intentions report showed that US farmers will plant 13.155 million acres to cotton, below last year’s 14.73 million acres. It was still deemed a bearish report, because the figure was well above average guesstimates of 12.75 million acres.
We believe, however, that cotton area is subject to downward revisions. New-crop soybean prices have outperformed new-crop cotton prices by a wide margin, and it is clearly more profitable to plant soybeans. Wherever possible, the switch from cotton to soybeans will be made.
The world’s top two cotton producers, China and India, account for close to 50% of global output. Cotton area for the 2012-13 crop in both countries is expected to drop by 10% from 2011-12. If global demand swings back, the market will be extremely vulnerable. Anything less than perfect weather for the new crops will tighten the market.
We have exhausted the downside of this market. Cover short positions in December cotton and establish long positions. Place initial protective sell stops at 84.5¢ per pound, close only.