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Cotton supplies at 10-year low

The next monthly USDA update
of cotton’s balance sheet in the US and abroad will be issued Thurs, March 9 at
8:30 AM EST.  As mentioned last
month, into the third quarter of the marketing year (Feb-Apr) production in the
northern hemisphere is typically close to its final level and consumption has
made the necessary adjustments in response to supply availability via procuring
cotton as needed until new crop is accessible.   This year is anything but typical especially for consumption
as the mixed data is providing fodder for both bulls and bears.  Beyond old crop, official data for new
crop will not be out until the May 11 report but the Dec 11 contract which best
represents 2011/12 season is divorcing itself from the nearby months.

US 2010/11 Cotton Supply
& Demand – In the US, unlike overseas, production and therefore supply have
been settled although the final ginnings report due out this month might lead
to small revisions in the May annual report.  At 21.3 mln statistical (480-lb) bales, supply is nearly 3
mln bales above the 2009/10 crop year but as mentioned in past reports, is a
10-year low.  As alluded to in the
introduction, if this was a typical year, the US would find itself as a
residual supplier of cotton to foreign mills but for the first time in recent
history, export commitments stand at 99% of the USDA estimate with absolutely
no wiggle room for additional sales given the low forecasted ending stocks
level.  Latest export data after 30
weeks place commitments at 15.09 mln running bales and shipments up to 7.51 mln
bales, 49% of the official forecast. 
If and there always is one, if every bale sold was going to be shipped
there would no room for change but as US cotton has shot beyond the 2.00 mark,
cracks are becoming more apparent with demand rationing taking greater
hold.

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Asian mills more so those in
China than elsewhere have been successful in passing along the resulting higher
price of yarn, cloth, etc due in part to their near absolute control over clients
downstream including retailers. 
Despite evidence from Cotton Inc that suggests the price increase cotton
has gone through should only result in very minor increases for retailers, they
are being subjected to much higher costs. 
Since their profit margins are historically thin, they were and are only
able to absorb so much of the higher cost per unit resulting in many announcing
price increases this quarter. 
Since the full brunt of cotton’s high price has yet to be passed
through, additional price increases are likely although the consumer will have
the last say whether they are willing to pay more for 1) all cotton/mostly
cotton products due to fiber preference, 2) chose cotton due to its “green”
label or 3) accept products with other natural and/or manmade fibers because of
price.  Hence, US merchants have
been able to make modest sales of old crop even at these very high prices but
they also encountering a new issue, a few foreign mills are unable or unwilling
to price on-call cotton because of its prohibitive cost.   Over the past few weeks, the
above mentioned cracks with demand have become more apparent with mills from
specific countries such as Turkey not pricing cotton already purchased in the last
week prior to FND with the March 11 contract or on set-backs as occurred the
week of Feb 21-25.  Cotlook has
mentioned recently the level of hesitation with pricing is fairly high and
since Turkey is the second largest buyer of US cotton, their mills’ willingness
to price on unfixed contracts is critical.  Referencing US export data from the week ending Feb 24, of
the 2.22 mln running purchased, 1.02 mln have been shipped leaving 1.20 mln to
be shipped if prices cooperate.  At
this point, it is impossible to say how much cotton sold to Turkey or other countries
will not be priced but the direction of US futures has been to the upside and
the higher that trend is maintained the more cotton that will not be
priced.  Merchants have a couple of
choices in the event of mills who opt not to fulfill their contract, either
take them to arbitration and seek repayment over time or re-sell that same
cotton, if possible, although any repayment would be substantially
reduced.  The on-call report as of
Feb 18 showed an increase in May unfixed contracts of 2,194, presumably most of
which involved mills rolling March positions forward delaying their pricing
decision in the hope of cheaper prices. 
If those cheaper prices do not prevail, more of the May unfixed
contracts, 21,891 as of Feb 25, may be rolled or abandoned.  Based on the increased number of
problems arising for foreign mills including delivery issues (which is behind
the lower NCC estimate), I am lowering my export estimate by 100k to 15.6 mln
statistical bales vs Washington’s of 15.75 mln.  By the time the May contract has gone into notice, Apr 25,
we should know if all of the above mentioned contracts were priced and if not,
the consequences for the market.  I
am also leaving domestic usage at 3.5 mln bales although data in the first 6
months suggest a stronger figure. 
Similar to foreign mills, those in the US are likely to succumb to the
pricing pressures shrinking their consumption by 100K bales vs the USDA
estimate.  Total demand at 19.10
mln bales is 250K bales below the WAOB figure and if prices continue to remain
as high as they are or move higher, some additional loss of demand will
occur.  Ending stocks are forecast
at 2.17 mln bales vs the official Feb 1 of 1.90 mln.  As a reminder US and foreign stocks were pegged at the
lowest possible level by the WAOB from their November 2010 forward reports and
consumption backed out as a result. 
Fair to say, the pending “showdown” may factor into their consumption
forecasts in the last 3-4 months of the crop year.

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US 2011/12 Cotton Supply
& Use – In light of cotton’s higher price in the past two months for new
crop and various comments from commercial sources regarding US producers’
preference for cotton over corn or soybeans, I am tentatively raising my
projection for US area to 13.2 mln acres. 
I will provide a region/state breakdown and any last minute tweaking in
front of the NASS Planting Intentions due out Thurs, Mar 31.

Area in the Southwest region,
which includes Texas could be much higher exceeding that of the past 30 years
but current dryness warrants a higher abandonment of 13.4 % (same as the 3-year
average) resulting in a national harvested figure of 11.47 mln acres.  My planted figure is slightly above
that USDA Ag Outlook forum number but the harvested figure is slightly
lower.  Employing a 5-year average
yield of 821 lbs/ac pencils out to a crop of 19.6 mln bales, 500K higher than
my February estimate.  When
combined with a slightly higher carry-in, supply could reach 21.8 mln bales,
also a half mln bales higher than this year.  Demand for US cotton will depend greatly on 1) how much
supplies rebound in key foreign countries and 2) how much overseas mills seek
to replenish stocks.  Tentatively,
the higher supply assuming prices are competitive should allow exports to range
from 13.5-15 mln bales with domestic usage a hair higher at 3.6 mln bales.  My guesstimate for total demand and
that is all it can be at this time is 18.1 mln bales, about 1 mln less than the
current year but above the two previous years.  Ending stocks from a crop in the mid-19 mln range and
exports 1 mln less than in 2010/11 should help stocks rebuild to a more
comfortable 3.7 mln bales.  One
caveat, if old crop shipments are delayed beyond Jul 31, it would inflate the
new crop export figure but not necessarily change carryout.

Potential price impact and
possible conclusions

As was the case with the
past few USDA reports, this one may not carry much weight beyond the first hour
or two as a lack of selling from commercials is keeping prices higher on a
day-to-day basis.  As described to
some of you, imagine a bakery with a long line stretching out the door and down
the sidewalk.  Until a customer is
allowed to buy a loaf of bread and leaves the door, the next customer cannot
step up for the next loaf.  Until the
shopkeeper is willing to sell another loaf, buyers have to bid the price of
bread higher enticing another (bakery) trader to risk going short or take
profits on his long(s).  The ever
higher prices seem to be scaring off some specs as the three key reports from
the exchange and CFTC continue to show decreased spec longs and in some
instances short covering by the trade due to the occasional mill fixations with
old/new business.

However, new crop is not
participating in the old crop rally and per commercial sources according to
Cotlook, the same disconnect also exists between cash and old crop
futures.  In its most recent price
commentary, Cotlook put the current situation very succinctly; they said
“offering rates appear well out of reach for many mill buyers at present,
particularly as local prices in a number of key import markets appear
attractive by comparison.”  
When the current situation with old crop implodes, it will not be pretty
and as also mentioned to some of you, I want to be as far away as
possible.  New crop by late this
month and certainly early April will be guided by weather and increasingly its
own fundamentals.  By late
May/early June, the Dec 11 contract should be the lead month with regards to
open interest.  What becomes of old
crop by then is unknown but cotton moving from the southern hemisphere may
moderate its behavior but the lack of players could also make for a very
dangerous market. 

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