|November 30, 2013 (United States Of America)|
The market has been flat-lined in November, with the March contract closing the last 20 sessions in an extremely tight range of less than 200 points, between 77.23 and 79.19 cents/lb.
One of the reasons for this anemic market is that speculators have left the cotton market in great numbers, either by exiting altogether or by cutting back their exposure.
Looking at the latest CFTC report as of November 19, we notice that total open interest for futures and options combined amounted to just 198’866 contracts. This compares to 217’473 a year ago and 317’388 contracts on March 19, when speculators were piling in on the long side, propelling the market into the low 90s.
The exodus by speculators has been quite conspicuous! In the “Non-Commercial” category, which is made up of hedge funds and other large specs, we currently have just 69 traders active on the long side, while 77 traders are holding short positions.
Back in March the numbers were 160 traders long vs. 54 traders short and even a years ago they still amounted to 101 vs. 80. In other words, ever since the market broke support last month and flushed out a large contingent of spec longs, these players have shown no interest in getting back into the game.
This leaves the trade in charge and when we examine its current position, we find that it is very close to what it was a year ago. On November 20, 2012, trade longs amounted to 43’751 contracts (vs. 49’690 now), while trade shorts were at 106’921 contracts (vs. 102’753 now). Even the number of traders was nearly identical, as 50 traders were on the long side (vs. 49 now), while 55 traders carried shorts (vs. 58 now).
There are definitely some striking parallels to last season, with the market’s price action showing the same weakness going into harvest and with specs, trade and index funds holding very similar net positions. The USDA painted a more negative picture back then, as the ROW (rest of the world) production surplus was estimated at 14.5 million bales vs.
Chinese imports of 11.0 million bales, whereas now the USDA projects a ROW surplus of 11.1 million bales vs. Chinese imports of 11.0 million bales. A year ago ROW ending stocks were expected to increase to a ten year high of 43.2 million bales, while they are estimated to be at just 37.9 million at the end of the current season.
Prices were a bit lower last November due to the slightly more bearish statistical picture, with March trading at around 72.50 cents. However, November marked the seasonal low and from there prices started to steadily rise, eventually settling into a range that saw the market trade between 82 and 94 cents for the remainder of the season. What prompted prices to rise a year ago and are we going to follow the same pattern this time around?
The single most important reason for prices to trend higher last season was the fact that Chinese imports proved to be greatly underestimated. Instead of the 11.0 million bales the USDA estimated Chinese imports to be last November, they ended up being over 9 million bales higher at 20.3 million bales.The same happened in the 2011/12 season, when Chinese imports reached a record 24.5 million bales, after the USDA had pegged them at just 14.0 million bales in its November 2011 report. Are Chinese imports going to surprise us again and beat estimates for a third season in a row?
We believe that there is reason to be less optimistic on Chinese imports this time around, because the Chinese government seems to be more determined to put a halt to these ever increasing stockpiles.
The Reserve officially launched a new round of sales auctions, offering stocks from the 2011/12-season at a base price of 18’000 Yuan/ton. Unlike this summer, when sales auctions were sweetened by a 1-for-3 import quota, there is no such deal available under the current program. The government’s reasoning seems to be that by offering reserve cotton at a cheaper level than this summer, mills will more or less get the same average price as under the 1-for-3 scheme.
Chinese import quotas are probably going to be limited to the TRQ (4.1 million bales) and possibly a few smaller processing trade quotas next year. However, there is still the possibility to import cotton outside the quota system by paying the full 40 percent tariff rate, although there have been rumors that the government may consider closing this ‘loophole’. But as long as these imports are allowed, they will act in support of international prices at around 82/83 cents landed China.
So where do we go from here? It is no coincidence that the market is currently stuck at this level. Even without any additional quotas we should see Chinese imports reach a minimum of 10 million bales this season and if international prices were to drop any further, buying against the 40 percent tariff would add to this number.
Since we estimate the seasonal surplus in the ROW at around 12.5-13.0 million bales, ending stocks are therefore not expected to increase by much, if at all. In other words, we have a stalemate from which the market seems to be unable to escape anytime soon. If prices rise, there will be enough cotton on offer to cap the rally and if prices drop by more than a few cents, Chinese buyers will come to the rescue.
With speculators on the sidelines, it will take a significant change in the fundamental outlook or some macroeconomic event to force the trade’s hand. Potential catalysts that come to mind include the new Chinese price policy for 2014/15, major shifts on the currency front, China disallowing imports against the 40 percent tariff or Chinese imports once again beating expectations. However, as things stand today, we are afraid that we are going to see a lot more of this boring trading action in the foreseeable future.
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