Cleveland on Cotton: 500 Point Surge and Blind Hogs

It is most challenging to grow cotton using your own money.

A cotton grower asked me to join him for dinner last Tuesday evening. I replied that since the market had fallen lower than I advised him that I would stay home in fear of being shot. Yet, he also asked in which direction the market would trade after the following day’s supply demand report. I advised him that the report would be bullish and prices were headed higher. I would gloat, but for someone who has missed as many markets as I – I cannot. He would only remind me that a blind hog could find an acorn. My reply to that would be that Ray Charles could have seen that the USDA August supply demand would be bullish. It was more than suggested in last week’s newsletter.

The market gained nearly 500 points this week, a nickel, supported by 2 consecutive days of triple digit gains followed by one with double digits. That puts prices smack dab in the middle of the 10 month trading range again. It also announces another charge at 70 cents. It leaves behind a life of contract low in December and paints a rosy price outlook for the out months.

December will move higher and the Cotton Group now estimates the 30 day trading range will be within the 62-73 cent boundary. It is difficult for me to disagree with them, but I see major price resistance between 68 and 70 cents. There will be so much grower price fixing near 70 cents it may be all but impossible to climb to new highs. However, that price resistance will fade away once the December 2015 contract goes expiry.

On that note, what does all the ICE empirical research show?  The best bet is to sell the physical crop at harvest and buy a three to four cent out of the money July call option. Pretty good advice, I think, even if it comes from a blind hog.

With respect to the 2014-15 marketing year, now in the books, USDA increased exports to 11.2 million bales and lowered ending stocks to 3.7 million bales. Strangely enough USDA will have to even further adjust last year’s exports another 100,000 bales higher to at least 11.3 million bales, thus, lowering ending stocks to 3.6 million bales. (Note there was solid strength in the deferred contracts in today’s trading as some are beginning to notice the shrinking level of 2016 stocks.)

The final export sales report, released a day after the supply demand report showed U.S. exports were nearly 100,000 higher than the USDA August estimate. Thus, 2014-15 exports included 10,535,100 RB’s of Upland and 394,000 RB’s of Pima for a total of 10,929.100 RB’s. Using a bale weight of 501 pounds indicates that U.S. exports climbed to 11.3 million statistical bales (480 pound bales). (All USDA cotton data is reported in statistical bales or recalculated as such in final data tables.)

As we had suggested in last week’s newsletter, USDA significantly lowered 2016 plantings, yield and production. Abandonment was also increased as had been expected. (Remember, if it is planted and then plowed up or not harvested for any reason it was still planted and then abandoned.)

USDA estimated the 2015 U.S. crop at 13.1 million bales, down 1.4 million from the prior month’s estimate. Note that this estimate was based on the first objective field survey of the year. Current season exports, estimated last month at 10.8 million bales, were lowered to 10.0 million due to the reduction of the U.S. crop size. I understand USDA’s logic in making that estimate.  However, due to the fact that the world supply of high quality cotton will be sharply diminished in 2015-16, it is likely that U.S. exports will be as much as 500,000 bales larger than the current USDA estimate. Planted acreage was estimated at only 8.9 million acres.

USDA made three significant 2016 crop year changes that made for an unprecedented report. The previously mentioned 1.4 million bale drop in the U.S. crop was followed by 1.0 million bale reduction in the Chinese crop. That was followed by 500,000 bale drop in the Indian crop. With those changes the world supply demand changes were significant.

World stocks were reduced 3 million bales, principally based on the aforementioned production changes in the world’s three largest production countries, also unprecedented. Carryover stocks were estimated at 105 million bales, down from last month’s estimate of 108 million bales. It is easily within the realm of Mother Nature to be the cause of another 1 million bale reduction in China, a 1 million bale reduction in India and another 500,000 bale loss in the U.S.  That is, our months-ago statement that world stocks could fall to near 100 million bales this year no longer looks out of line. That first of the year statement was based on a discussion of the world wide weather which have continued.

Additionally, it should be noted that the Chinese reserve auction sale has been all but a total failure. Chinese mills are struggling to cover variable cost and the reserve stocks are priced well above the market. Further, the available U.S. stocks owned by the Chinese reserve are also priced well above current crop cotton and thus have not moved either.  Finally, the market is beginning to understand that the Chinese stocks are not a drag on prices.

The Final Piece of the Puzzle…Certificated stocks are declining almost every day, not by a lot, but then, there are not a lot of them. The export market took the vast majority of the free stocks held in the U.S. Now as the October contract approaches first notice day, less than a month away, the pool of cotton available for delivery has all but disappeared. The old fashioned October squeeze may be in the works.  It has been some time since we have seen that. I hope it happens. The new guys need to see one in action. I like higher prices, but remain cautious due to the grower hedging that must to done.

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