The USDA keeps “finding” more cotton (NYBOT:CTH14) inventories. Lower Chinese output constituted the only significant production or consumption revision to the 2013-14 marketing year in the December crop report. But 2012-13 ending-stock estimates were increased, putting 2013-14 ending stocks at yet another record high of 96.41million bales, or an astounding 87.9% of consumption.
The recent rally in cotton prices has some rationale. There were several bullish developments, two of which involve China. On the supply side, early frost and snow in key growing regions lowered yields. The USDA lowered its estimate for the Chinese crop from its November estimate by 500,000 bales, to 32 million bales.
Actually, traders were surprised by the conservative downward revision. Coming into the report, the China National Cotton Reserves Corporation estimated that the damage to the crop was far more extensive, putting output at only 30.7 million bales. So it’s a good bet that the January USDA report will trim its estimate further.
Then, on the demand side, the level of Chinese imports will ultimately determine the price of cotton. China is the single largest buyer of U.S. cotton, despite the fact that its inventories are bursting at the seams. Mills import cotton because the amount of high-quality cotton in the Chinese stockpiles is limited. There were concerns that the government was planning to restrict imports to make a dent in the burdensome inventories by changing the import tariff system. Bulls were pleasantly surprised when the government instead announced changes that would effectively maintain import incentives.
The other bullish issue – of a longer-term nature – is that rising production costs may curtail planting for the upcoming 2014-15 season. The world may very well be awash in cotton now, and it may take some time to reduce inventories, but that situation will not last forever.