Turning bearish on the cotton market back in July after a long stint of bullishness gave us a severe case of whipsaw. December cotton (NYBOT:CTZ13) sailed right through our 88¢-per pound buy stop, on its way to 93¢. Within a few days of the peak, prices plunged, on their way back to 82¢.
During the planting-decision season, there was little incentive for farmers to plant a large cotton crop. Global inventories were burdensome, to say the least, and soybean planting was a more profitable alternative. The most recent estimate for U.S. cotton acreage was 10.2 million acres, down from 12.31 million acres in 2012-13 and 14.74 million acres in 2011-12. The smaller crop seemed adequate to meet both domestic and export requirements.
As the growing season progressed, however, the crop was hit with bad weather. Yields deteriorated, and estimates for a high abandonment rate grew. The Aug. 12 USDA monthly crop report lowered the crop estimate to 13.05 million bales, down from the 13.5-million-bale July estimate. More importantly it was significantly below the average street guesstimate of 13.75 million bales. The abandonment rate rose to 25%, about the same as last year, but not as bad as the 36% seen in the disastrous 2011-12 crop year. Still, it was much worse than the previous 10-year average of only 10%.
Weather has improved since the August crop report and is likely to be reflected in the September crop report estimates, but much of the damage is likely done.
The status of the U.S. crop, however, is merely a diversion from the broader issues, which are decidedly bearish. Actually, to be more accurate, it should be issue, in the singular.
There is an ongoing uncertainty regarding the future of Chinese imports. As we discussed in our most recent article on cotton, Chinese carryover stocks have ballooned to over 58 million bales. That’s up from 50 million bales in 2012-13 and dramatically higher than 31 million bales in 2011-12.
The Chinese government is reportedly in the process of overhauling its stockpiling policies, which effectively made it cheaper for cotton users to import rather than buy domestically grown cotton. The USDA estimates that Chinese imports from all sources will fall by close to 50% from 2012-13, although some analysts see continued robust Chinese imports for the foreseeable future. Hard evidence suggests that Chinese imports have already slowed down materially. For the new 2013-14 marketing year, which began Aug. 1, total Chinese purchases from the U.S., including shipped and unshipped, total 488,000 bales. In the comparable period last year, 1.821 million bales were sold to China.
The forecast for global ending stocks was revised in August to 93.77 million bales, or 85.36% of usage, down slightly from the July estimate of 85.9%. Lower production estimates for the U.S. and China were partially offset by an increase in the estimate for carry-in stocks from the 2012-13 marketing year. But with the magnitude of the overhang we’re looking at, the downward revision in ending stocks is largely meaningless.
If China were to start chipping away at its stockpile, the market would collapse. The rally that stopped us out of our short position was the result of an unwarranted focus on the U.S. crop. We do not believe these price levels are sustainable. Cotton is a particularly volatile market. Look to reestablish conservative short
positions in December cotton on rallies. Place initial stops at 90¢ per pound, close only. Risk averse accounts, not prepared to risk such large losses, should avoid the trade.