With cotton crop estimates for the US and India increasing week after week due to the swift advance of harvest and surprisingly good yields, selling pressure eventually became heavy enough for December to break through important support just below 82 cents on Wednesday.
This opened the floodgates, as spec longs pulled the plug on positions and the trade was busy adjusting options strategies to the lower price level. Over the past two sessions, during which the market dropped more than 300 points, futures volume spiked to a combined 73’701 contracts and nearly 49’000 options changed hands.
After all the problems that were thrown at the US crop earlier this season, a near perfect finish has been boosting yields and it seems possible that the final tally will show a crop as high as 13.6-13.9 million bales. This would be quite a jump from the USDA September estimate, which pegged the US crop at 12.9 million bales.
The same is true in the case of India, where a bumper crop is definitely in the making, with most estimates now calling for a crop between 38.2 and 39.0 million domestic bales. It is therefore conceivable that there will be another 0.5 million bales upward adjustment to 29.5 million statistical bales in the next USDA report.
The only major crop that will probably be scaled back is China, where private and government estimates are all at least a million bales below the most recent USDA estimate of 33.0 million bales. We therefore expect the Chinese crop to be adjusted lower to somewhere between 31.5 and 32.0 million bales.
Although overall global production may not differ much from the USDA September estimate of 117.4 million, because a reduction in China should more or less offset gains in the US and India, these changes nevertheless have implications for world prices.
If crops in the US and India were to increase by let’s say 1.5 million bales, then the production surplus outside China would grow to 12.4 million, assuming that there are no changes elsewhere in the ROW balance sheet. This means that China would have to import 12.4 million bales instead of 10.9 million bales in order to keep ROW stocks from increasing.
This raising of the bar in regards to Chinese imports is probably why prices have trended lower, as traders feel that the fast arrival of Northern Hemisphere crops is going to weigh on the market, while it remains to be seen whether China will once again come to the rescue to lift this pressure during the course of the season.
A larger US crop combined with favorable harvest weather is probably going to increase the availability of tenderable grades, which is helping to force carry back into the market. There are currently about 150-160 points carry between December and March, which is likely to increase further in the weeks ahead.
The same is true for the March/May and March/July spreads, which should continue to widen as well. The recent increase of the certified stock, which as of this morning measured around 144’000 bales (including bales under review) has definitely helped to build carry. However, we still wouldn’t rule out a sudden sale of the existing stock, since it is now quite attractively priced and available for prompt shipment.
So where do we go from here? The market has clearly sustained some technical damage by breaking through long-term support dating back to early February. The question is where will new support most likely emerge from and at what level? The bulls’ biggest hope rests with China, who is expected to remain a strong importer of cotton and yarn.
With the Chinese Reserve once again absorbing a lot of new crop cotton (nearly 600’000 tons so far), free supplies within China are relatively tight and since Reserve auction sales may get delayed until early next year, buyers may be forced to pursue imports. Remember, cotton can be imported without a quota if the full 40% duty is paid! Based on our calculations it would seem that such imports become feasible once the futures market trades in the mid-to-high 70s.
Based on momentum indicators like the RSI and Stochastics the market looks quite oversold at the moment and we should therefore expect a bounce to occur at any time. Specs are likely to use rebounds to add shorts and/or lighten up on longs, but on the other hand it may prompt mills to buy and fix additional supplies.
Former support at 81.71 in December has now become resistance and we see it as unlikely that the market will settle back above it anytime soon, due to increasing harvest pressure. At best the bulls may hope for a 3-5 cents lower trading range, but we wouldn't rule out a further drop towards 75 cents unless China shows up as a strong buyer.
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