Thompson On Cotton: Expect Wide Basis Ranges Based On Quality

Last week’s market was dominated by the roll activity of merchants, funds, and specs. Indicative, Open Interest on the March futures contract surpassed December as daily trading volume reached record levels. Technically, March now becomes the cover month for the current crop.

With December closing the week nearly unchanged at 68.46, March settled at 70.40, creating a spread of almost 200 points. Looking at a weekly chart, March is up two weeks in a row with moving averages remaining positive and the uptrend unbroken.

The biggest surprise of the week came Tuesday in USDA’s monthly S/D report. Most everyone was expecting a reduction in the U.S. crop of half a million bales or more. To our astonishment, production was raised slightly.

Despite a harvest season fraught with numerous hurricanes and freezing rains, the U.S. crop is now estimated to be 17.1 million bales and not the 16.5 most thought.

The only logical explanation, if there is one, could be that USDA was very conservative in their earlier predictions. Compared to the October report, yields were lowered in only four states, Alabama, Florida, Missouri and North Carolina, while estimated yields in the two highest producing states, Georgia and Texas, remained unchanged.

Most concerning, regardless of which is correct, domestic and global ending stocks will be at their highest levels since 2007/08. This will intensify the need for greater cotton demand. It’s here that we are slowly beginning to see some improvement.

As a result of Covid-19, U.S. apparel imports in March versus the previous year dropped 55 percent, accompanied by declines in the EU and UK of 40 percent. At the same time, garment exports fell 85 percent in Bangladesh, 90 percent in India, and 60 percent in Pakistan.

Disposable Income Rises…A Positive Sign

Though not obvious, there is a positive to be found here. In 2008 with a similar decline in demand, it wasn’t met with a decline in processing, thus there was a massive buildup in supplies. As demand increased, this huge inventory of apparel had to be liquidated, which slowed the recovery effort.

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Today, however, the supply chain is empty, so look for a quicker recovery once demand returns. All this hinges on consumer spending where there are signs that pent up demand could become a factor.

Since February 2020, savings deposits in the U.S. have grown by over two trillion dollars. Also, with a likely change in the presidential administration, the odds of another stimulus package increase. This additional disposable income could greatly aid the recovery process.

That said, don’t expect these recovery efforts to fully take hold until we escape the grip of this persistent virus. Sadly, another wave is sweeping across continents with daily reported cases reaching record levels.

Many countries are revisiting and reinstituting economic restrictions. Hopefully, we learned our lesson and will target these restrictions in lieu of complete shutdowns thus minimizing economic damage until a successful vaccine is discovered.

Basis Will Sort Out Into Two Batches

Where do we go from here? Those with cotton sold on-call based December have five trading sessions before first notice day. We would discourage a roll to March for the cost is too high and risks are too great.

Cash sales and call options would be a better strategy for those willing to gamble on a future price rally. In the Southeast, fiber quality is becoming a serious issue. If yield losses weren’t enough, a high percentage of seed coat fragments is being detected in samples.

Alarmingly, almost one-fourth of the crop is affected. Worse than the bark issue we had in 2018, the most likely culprit is the same: wet, cloudy, humid weather at harvest.

In keeping with the year 2020, which seems to be 10 years long, this is just another curve ball which will have to be dealt with when marketing this crop. As the volume of more desirable qualities shrink, look for the basis on high quality clean cotton to strengthen while that with extraneous matter will be further discounted.

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