It seems to have been a temporary problem. Certified stocks in the U.S., which can be delivered at the exchange, have fallen to historic lows. This ignited fears that a squeeze will follow on the December contract. Some early-harvested cotton has been of poor quality, and traders are concerned that it may not meet deliverable grade. The December/March spread, which had been in a moderate contago since the summer, quickly spiked to a 2-cent backwardation (Chart 2).
The U.S. harvest is 38% complete, in line with the five-year average of 39% for this time of year, and the tight stock situation should be alleviated soon enough. The first small increase in certified stocks, indeed, ended the panic. Prices and spreads reverted.
The demand side has not been particularly supportive. The USDA forecast is calling for U.S. exports of 11.6 million bales, down only 1% from 2011-12. Commitments for the 2012-13 marketing year, which began on Aug. 1, however, stand at 5.6 million bales, down 16% from the same time last year.
A closer look reveals a bit of a silver lining, though. At 1.55 million bales, or 27% of sales to date, shipments are stronger than last year at this time when shipments were only 1 million bales, or 15% of sales to date. That could mean that the demand is there, but buyers are confident of lower prices down the road.
We’re not actually bearish, though, and we have no interest in being short this market. The market could drift lower with harvest pressure, but the downside is limited. As we’ve pointed out in the past, production costs have increased significantly to around current price levels, which is generally not a great incentive to grow cotton when you can grow alternative, more profitable crops.