The market made several futile attempts to get something going to the upside this week, rallying early in the session but getting rejected at the end of the day. After the technical damage the market sustained last week by violating a 5-month uptrend line, it came as no surprise that it would be difficult to generate any upside momentum.
Speaking of the chart, the market suffered additional setbacks this week, first by braking through the 58 cents support level in December, which dashed any bullish hopes for a double bottom formation, and then by penetrating through the weekly uptrend line dating back to March. On the latter there is still a chance to put a positive spin on things if the market somehow manages to rally 100 points tomorrow to post a close above that trendline.
Although the chart doesn’t look inspiring and we shouldn’t expect much more than a relief rally due to oversold conditions in the near term, we are not too worried about the market falling apart from current levels. When prices broke through 58 cents we saw a spike in volume for a couple of days as some sell stops were triggered, but there was no follow-through selling when the market dipped below 57.00 cents this morning, as less than 5’000 contracts were traded all day and the options market was even more disengaged with fewer than 2’500 contracts changing hands.
The same cannot be said of the physical market, which has turned quite active lately as evidenced by the latest export sales report. For the week ending on August 20 there were 243’700 running bales of Upland and Pima sold to no less than 23 different markets, which brings total commitments for the current marketing year to 2.95 million statistical bales. Shipments amounted to 215’000 running bales, bringing total exports so far to about half a million statistical bales. From what we can tell export sales continued at a decent pace this week and this demand, along with the many mill fixations that are waiting on a scale down basis, should provide the market with a strong layer of support from current levels on down.
Although US cotton has been competitive during this latest round of sales, almost all of this business consists of old crop remnants, while new crop offers remain uncompetitive at the moment. When we calculate how much US old crop is still unsold, we come up with around 2.0 million bales. Starting with beginning stocks of 6.1 million at the 1st of August, we subtract export commitments (estimated at 3.2 million including this week’s sales) and at least three months of domestic mill use (0.9 million bales). This leaves around 2.0 million bales, which is substantially less than last season, when unsold inventories amounted to roughly 4.4 million bales at this point in time.
In other words, it will only be a matter of time before these old crop supplies run out and then it will be the market’s task to get US new crop into the marketing channels. For that to happen we need a wide enough AWP/futures spread in order to lure new crop cotton out of the loan. Based on next week’s AWP of 46.13 cents, the current spread to December futures amounts to just 1151 points, which is about 4 to 5 cents shy of what it needs to be. The question is how will this spread be allowed to widen? Are world prices going to fall while futures hold steady or will there be a rally in futures?
When we look at the current composition of the A-index, which provides the base values for the AWP calculation, we notice an unusually wide difference of seven cents between the five cheapest components that make up the index. Pakistan is by far the cheapest at 57.50 cents, followed by Tanzania (60.00), Brazil (63.75), India (64.50) and Mali (64.50). There are another five origins following between 64.50 and 65.25 cents.
Pakistan and Tanzania are considered lightweights in terms of exports and will not set the price trend throughout the season. The USDA currently forecasts both countries to export just 300’000 bales this season, although in the case of Pakistan that number is likely to go up. If we were to exclude Pakistan and Tanzania from the calculation and just focused on heavyweight exporters instead (India, Brazil, West Africa and CIS), the current A-index would calculate 64.40 instead of 62.05 cents and the AWP/futures spread would be even narrower. When we look at who among these heavyweights could potentially lead prices lower, it would probably have to be India. Brazil has a strong domestic price, West African values should remain relatively firm at origin due to smaller crops and Uzbekistan is more of a follower than a leader.
Again, US new crop (once harvested) will not be in the picture for a while because it first needs to escape from the loan, which in turn will depend on what competing crops are up to. How aggressive India will be with its exports it still up for debate, because even if there was a large potential export surplus we might still see the Indian government stick to the policies of last year, when it instituted a minimum support price and took supplies off the market, a strategy that ultimately proved to be quite successful.
It will be interesting to see how this causality dilemma plays out this season. We see it difficult for US new crop to enter the game, and without the US competing there will be less pressure on others. Only once a big block of US cotton has been flushed out of the loan will the dynamics change, and for this to happen we will probably need to see a rally in the futures market first.
So where do we go from here? Based on the technical picture the market should work lower, but the trade may prevent this from happening. We feel that the market has value below 57 cents and should be bought on a scale down basis. Other than some old crop supplies that still need to find a home we don’t expect to see any pressure on the market until the major crops are harvested. At the same time there is no reason for the market to run away to the upside either. We therefore stick to our prediction of a trading range between 55 and 65 cents for the time being. |
