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.