With the storm clouds of the European debt crisis threatening to wreak economic disaster far and wide, it’s a bit difficult to focus on bullish fundamentals of individual markets. This is particularly true for any commodity whose fortunes are dependent upon Chinese imports. With a softening Chinese economy and constant warnings that growth rates will continue to decline, potentially bullish arguments are sometimes overlooked.
The cotton market is a prime example. Strong old-crop US export sales took the market by surprise. Do they signal a bottom for cotton prices?
Actual usage data in China indeed show an unmistakable decline in economic activity, at least as regards cotton. For the current, 20011-12 marketing year, the estimate for Chinese domestic mill usage has fallen steadily – from an early-season forecast that reached as high as 48 million bales, to the most current reading of 41 million bales, which fits perfectly with the slide we’ve seen in cotton prices (Chart 1).
Despite the apparent weak demand, the Chinese have committed to stockpile cotton, and the import statistics show this clearly. Early forecasts called for only 16 million bales of Chinese imports, but the most recent estimate in the USDA’s June crop report was 23.25 million bales, revised upwards by 175,000 bales from the May estimate.
We’re very late in the 2011-12 marketing year for cotton, which ends on July 31, yet old-crop US exports are still in high demand. For the first week of June, export commitments were just under 800,000 bales, one of the largest weekly tallies in history. We haven’t seen a weekly number like that since April 2007. A typical week in the active part of the season sees sales in the 200,000-bale to 300,000-bale range. Of the total, 744,000 bales went to China.
Old-crop sales were flat the following week, but new-crop sales were 471,000 bales, still a very robust result.
The USDA again revised upward its estimate for US sales in the June crop report, by 200,000 bales, to 11.6 million bales. With commitments now at 12.5 million bales, that estimate will be subject to another revision. Shipments over the past four weeks averaged 250,000 bales. With the fresh jolt of old-crop sales, shipments will have to be considerably higher than that to meet the USDA’s target for annual sales. In any case, the flow of US exports has been much better than anticipated. If foreigners do not cancel any of their commitments, a rough calculation would put 2011-12 US ending stocks at or near record lows.
In looking ahead to the 2012-13 marketing year, we find that expectations of a recovery for the Chinese milling industry are running low. The USDA’s first estimate in May was for zero growth, at 41 million bales, well below the historical norm. The June crop report revised that forecast down by 1 million bales. That would be the lowest Chinese cotton consumption since 2004-05.Certainly, if that scenario played out as predicted, we would see export sales dry up sooner or later because of the shopping spree we’ve witnessed over recent months. Using current estimates, Chinese ending stocks for 2012-13 would shoot up to 31 million bales, or a gargantuan 78% of usage.
Virtually all key producing countries have planted fewer acres for the 2012-13 crop year than they did for 2011-12. The US will harvest a larger crop than it did in 2011-12 regardless, because of the disastrous crop failure. So the global crop will be just a bit smaller than last year, but consumption will be down by 5% according to preliminary USDA estimates. That would leave a burdensome, record-by-far, 67%-of-usage global carryout.
As a result, the extraordinary export activity notwithstanding, it’s hard to make a convincing bullish case with the way the balance sheet looks now.
There are, however, two areas of vulnerability. It’s early in the growing season, and the major producers must get through without crop problems. In addition, the assumption that Chinese mills will not use more than 40 million bales for the second consecutive year could turn out to be misplaced.
We believe that all the bearish possibilities are embedded in the new-crop prices. December cotton is trading at or below the cost of production. At one point this month, the spread between new- and old-crop prices soared to soared 13.5¢, and even after collapsing, still presents the opportunity to buy a substantial discount to spot prices (Chart 2).
Buy December cotton. Place initial stops at 64¢ per pound, close only.