PCG Email Services pcg_email_service at plainscotton.org
Fri Apr 18 10:44:35 CDT 2014

April 16, 2014


NY futures rebounded this week, as July gained 205 points to close at 92.34 cents, while December moved up 110 points to close at 81.94 cents.

Trade short covering tied to mill fixations and the liquidation of additional basis-long positions generated enough buying power this week to avert a trend reversal and to lift the July contract back above its 5-month uptrend line. The bulls were lucky that July has taken over as the lead month after the index roll, since the May chart doesn’t look nearly as healthy.
The liquidation of the May contract has advanced quite rapidly this week, as only 18’607 lots remained open before today’s session, while July open interest has shot up to 100’756 contracts. Overall open interest in current crop futures remains relatively high at 119’363 contracts or 11.94 million bales, as the majority of traders have simply rolled their shorts forward to July instead of opting out. 
Mills, who as of last Thursday still had 3.74 million bales to fix, compared to 2.44 million a year ago, are still hoping for a big break in the market to help them get out of trouble. The same goes for the many basis-long positions the trade still carries, which have taken quite a hit lately as the basis for most origins has weakened by about 300-400 points since January. Unfortunately we don’t see an easy way out from this basis trap, since the unwinding of these positions, i.e. selling physical while simultaneously buying back futures, only seems to exacerbate the problem.  
US export sales were surprisingly strong last week considering how little remains for sale, as 230’800 running bales of Upland and Pima cotton were sold for both marketing years, split between 95’000 bales for shipment until July and 135’800 bales for August onwards. We assume that around two-thirds of the bales that have been sold for ‘next marketing’ year are being supplied from existing stocks for delivery during the August/October time frame. Shipments of 297’200 running bales were once again stellar, bringing total exports to 7.7 million statistical bales so far.
We estimate that no more than 1.3 million bales of US cotton remain available for sale at this point. Supply amounted to only 16.8 million statistical bales this season (3.9 beginning stocks + 12.9 million crop), of which 10.0 million have so far been committed for export and a further 3.6 million will be used up in the US by the end of July. But we also have to account for another 1.0 million bales of US mill use between August and October, plus a similar amount of exports during that time frame. Adding it all up, we believe that a total of 15.5 million bales will have to be supplied from existing inventories. South Texas will start to bring some relief in the 3rd quarter, but the bulk of the US crop won’t be available until the 4th quarter. 
An important consideration in regards to the above is that when forward sales are made, they typically consist of tenderable qualities, such as 21s, 31s and 41s with premium mike, while discounted grades are only offered after the crop has been harvested. We therefore believe that a majority of these 15.5 million bales in commitments consists of tenderable grades. However, this season yielded only about 7.5 million certifiable bales, plus an estimated 2.5 out of the 3.9 million bales from beginning stocks, which adds up to a total of 10.0 million bales. It is therefore quite conceivable that there are no tenderable bales left to play the cert. stock game.
We will find out soon enough, as First Notice Day for the May contract is next Thursday, April 24th. Even though the certified stock is approaching 300’000 bales, it remains to be seen whether it will actually be made available or whether it is just for show like in March. And even if the current owners were to let it go, there would probably be some takers now that the May/July spread has gone to more or less full carry.
It looks like the market has once again been underestimating China’s willingness to import cotton - for a fourth season in a row. In March China imported another 1.02 million statistical bales, bringing total imports for the first eight months to 9.92 million bales so far. Even though the press put a negative spin on the March import number, since it was the lowest reading since November, we would argue that if China continued to import a million bales a month for the remainder of the season, it would amount to 14.0 million bales, or 2.0 million bales more than the current USDA estimate. 
In other words, Chinese imports are still too strong at the current pace and will therefore further deplete already tight ROW inventories. Considering that the Chinese government is in the process of issuing an additional 2.8 to 3.7 million bales in processing trade quotas at the moment and that potentially another 1.5 million bales in sliding scale quotas may be granted based on a Reserve auction ratio, it becomes clear that China will remain a strong factor on the trade front. Although it may defy logic that China would let its stockpile grow even larger than it already is – and by allowing all these quotas that’s exactly what's going to happen – the trade has learnt the hard way that it doesn’t pay to bet against China. 
So where do we go from here? As May enters its notice period next week anything can happen, although the availability of carryings should ensure that there are going to be some takers if certified stock were to be made available, which is still a big IF in our opinion. 
July still has way too many shorts in the game for our taste and with liquidity likely to dry up until the next roll period in early June, we see the potential for short-covering rallies as basis-longs head for the exit and mills fix additional quantities.
December is still undervalued in our opinion, especially with China issuing additional import quotas. Also, let’s not forget that in two months from now index funds will have to roll their longs to December and based on the current inversion to July they would have to buy an additional 6000 – 7000 bales in order to maintain the same dollar investment. This translates into a decent amount of buying power and we don’t believe that the trade will provide a matching short position unless the price becomes more attractive.
March may be the first month to feel any bearish pressure, but only if there are no hiccups on the production side. In other words, there is still plenty that can go wrong, like a prolonged drought in West Texas or a subpar monsoon in India, and we would therefore approach the short side only via put spreads at this juncture.


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