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Sharon Johnson: Tight cotton stocks

The USDA reports contained
friendly if not bullish surprises by tightening up the balance sheets for US
and World cotton. US production was cut as expected pulling ending stocks down
to 1.6 mln bales, its lowest level in recent history. World stocks were also
cut and by 780K to 41.55 mln, its’ lowest since 1995 due a combination of cuts
to production and increases to consumption. US cotton futures remained positive
after the release but were unable to hold its gains and began a deep sell-off
culminating in old crop months being down about 500 pts versus new crop which
was slightly higher. As has been the case for the past few months, the market
quickly turned away from trading the USDA numbers and focused on other factors
which in this case was correcting this week’s 20-cent rally in the May
contract. In addition, Friday was last trading day with May options requiring
some “evening up” prior to the exercise of in-the-money calls and puts. Per
open interest from Thurs, there were nearly 17K calls and 3500 puts in the
money based on Fri’s close. Futures volume was heavy at 35,081 as sizeable
rolling by index funds continue from May to July. Cert stocks rose to 214,152
with another 6,953 under review for a possible total of 221,105 bales. There
are only 9 business days left prior to May’s first notice day of Apr 25.

0411cotton1.jpg

2010/11 US Cotton Supply
& Demand – As expected, the WAOB did embrace the final ginnings figure for
US production of 18.1 mln statistical bales. To justify the drop, this agency
reduced yields by 10 lbs to 811 lbs/ac but next month’s report from NASS will
indicate if it is area, yields or both that fell. To the chagrin of bears,
demand was not only left as is but domestic usage inched up 100K bales to 3.7
mln bales, an increase of 7% from the preceding crop year. Data from the first
7 months may support a year over year jump but record high cotton prices will
mitigate that gain by the end of the crop year. There are other reasons behind
the usage increase such as new cotton spinning equipment investment in the US
that argue in favor of higher usage in the upcoming season and beyond (similar
to India). However, when the last monthly consumption report is issued in
August for the month of July, US mills are likely to have consumed less than
the higher annual figure issued by Washington in their Apr report.

Exports were left at 15.75 mln
bales and weekly and accumulative sales and shipping figures support as much. Despite
impressive data as of the 35th week, which represents the two-thirds completion
of the crop year, foreign mills are expressing increasing resistance to the
2.00+ cash prices of imported cotton especially in those countries who have
access to cheaper domestic supplies. No where is this more evident than in
China where mills and merchants are selling US cotton back to those same
merchants from whom they purchased cotton. In that regards, the 3 mln bale cut
to Chinese usage made by the USDA last November is proving to be warranted. The
USDA reversed an earlier decision by reducing China’s cotton imports by 500K on
this report, whether that reflects difficulty in obtaining cheaper Indian
styles or refusing to take more expensive US cotton or both is unknown but
those are likely.

The impact of the 2.00+cash
price will become more obvious in the last quarter of the crop year (May-July)
with reduced US shipments. As a reminder, the on-call report as of Apr 1 shows
3.0+ mln running bales not yet priced with the July contract and that amount
will likely grow as a small portion of the May contracts are rolled into July.
It will not be until Apr 21 and possibly Apr 28 before the size of May rolls
are known as the on-call reports lag by 6 days meaning as of Apr 15 if not Apr
22. Rolls into new crop and cancellations have become more obvious this past
month and that trend will not only continue but increase in the last 4 months
of the marketing year. Total demand of 19.45 mln bales is not sustainable given
how much pressure it puts on ending stocks. The USDA is predicting a carry-out
of 1.6 mln bales which is not enough to bridge the gap until new crop supplies
are available. Hence, US futures will remain high enough, long enough to push
foreign demand to other suppliers and failing that, reduce foreign cotton
consumption. However,
there is one caveat, record production out of southern hemisphere that will
help foreign mills meet their needs and in the case of Brazil, into the next
crop year, a fundamental not obvious in this year’s balance sheet. My carryout
figure is 1.95 mln bales but this number is too small even with US/foreign
mills taking longer downside for maintenance, repairs, etc Aug 1 forward.

0411cotton2.jpg

2010/11 World Cotton
Production – On a global basis, cotton area was expanded to 33.55 mln hectares
due to larger increases in Brazil and India vs decreases in Burkina Faso, Cote
d’Ivoire and Turkey. The area changes other than in the two Afr Fr Zone
countries came by way of the Ag Attachés reports from the past week. This year’s
area of 33.55 mln hectares is a jump of 11% from 2009/10 and represents a
4-year high. The world yield was cut by 5 kgs to 743 kgs/ha due in part to the
11 kg cut in the US. Since we do not know if US yields are actually down that
much, I will focus on the foreign yield decline of 3 kgs to 719 kgs/ha. Individual
changes include yield increases to Mexico and Turkey but decreases to Burkina
Faso, Cote d’Ivoire, India and Pakistan. Here too, changes made were via
reports by Ag Attaches in Brazil, India, Turkey and Pakistan. Production was
upped to 9.0 in Brazil, a new record with Mexico increased from 620K to 680K
bales. Pakistan’s production was cut by 100K to 8.7 mln bales as well as modest
cuts to the two Afr Fr Zone countries mentioned above and Turkey. Of all the
changes the USDA made, they did not adopt the lower figure for Australia put
forth by the Ag Attaché at 4.38 mln bales vs their own of 4.5 mln. As with
Pakistan, they may be waiting for more evidence with yields before revising
their figure just as harvest is getting underway. At 114.53 mln bales, the
world crop is down 420K bales from the March estimate but 13.2 mln bales above
the previous year’s level.

2010/11 World Cotton Supply
& Demand – Two changes were made to last year’s balance sheets, imports
were lowered by 120K whereas Pakistan saw an increase of 300K netting a gain of
188K which improved 2009/10 ending stocks by that amount to 43.99 mln bales.
Unfortunately, that was not enough to offset the 420K loss to production
pulling supply down to 158.52 mln bales maintaining its rather dubious
distinction of being the 7th smallest since 2003. To nearly everyone’s surprise
barring the most ardent of bulls, consumption got a boost of no less than 510K
bales to 117.12 mln bales, well above the past two seasons but below that 2007’s
of 119.7 mln. Pakistan accounted for the majority of the increase with a jump
of 300K to 10.5 mln although supply only increased by 70K bales. Other more
modest gains were shown with Vietnam (120K), Mexico (70K) and Thailand (50K) vs
a decline of 100K to 4.4 mln in Brazil. Thailand’s Ag Attaché also issued a
report this past week with larger usage so it appears the WAOB split the
difference by raising their figure to 1.65 mln bales. Despite his larger figure
for this year compared to 2009/10, the Ag Attaché included the following
comment in his report, “

0411cotton3.jpg

“Over the past month or so,
several organizations including Cotlook have lowered their consumption estimate
in light of what has occurred with cotton prices even in the face of rising but
still more competitive other natural and man-made fibers. The methodology used
by the USDA in determining consumption is typically based on global GDP 
growth and in normal years
that is a fair and reasonable approach. However, in extreme years such as the
last recession and this year’s record high prices, their method for projecting
consumption and even attempts to alter those methods often fall short. There
always has been a difference in consumption by Cotlook and the USDA but this is
one of those years where the figure from the former of 114 mln bales is likely
to be much closer to the final figure than that employed by the latter at 117.1
mln bales. Regrettably, it will be many, many months and possibly years before
this year’s consumption is truly known as the demand rationing and in some
instances, destruction, is an ongoing process. Since cotton prices did not go
ballistic until last fall and really hit the stratosphere Q1 of 2011, the
pressure on demand and margins will continue beyond Jul 31, 2011 (the end of
the marketing year) and be felt through all of 2011. The upcoming northern
hemisphere crop will not hit domestic mills until late fall and foreign mills
until Dec 2011/Jan 2012 and if production is large enough, prices will drop
accordingly resulting in higher consumption and improving margins. But as we
all know, a crop in the 118-123 mln bale is insufficient to make a marked
difference with ending stocks and therefore with prices. Those mills holding
their collective breaths waiting for larger/cheaper supplies may be
extraordinarily disappointed with the inevitable negative influence on cotton
consumption into if not through 2012 as well.
 

There were some interesting
changes made to trade as exports were lowered in the Afr Fr Zone due to the
smaller crop. Despite a larger crop in Brazil, its exports were reduced by 350K
most likely reflecting the timing of available cotton after Aug 1, 2011. As
mentioned above, China’s imports were reduced from 15.5 to 15.0 mln bales even
though some traders contend their crop is smaller. US merchants have been open
in their efforts to buy-back cotton previously sold to Chinese merchants/mills
given their difficulties in providing some styles such as that bought from
India and the cheaper price of cotton within China. The re-sale of cotton to
merchants handling US cotton by entities from within China has also become
quite common the past several weeks although there is import interest further
out in the calendar year. With no other change to China’s balance sheet, its
ending stocks bore the brunt of the reduced imports being cut to 12.696 mln
bales, its’ lowest since 1994. The Pakistan’s carry-out also got a haircut of
280K to 2.28 mln bales, its’ lowest since 1997. Because of its smaller crop,
Turkey’s ending stocks were reduced by 100K to 1.21 mln, also its’ lowest since
2000. India fared a bit better with its ending stocks only down 170K to 5.35
mln but that is also its’ lowest since 2003. As mentioned above, US carry-out
is forecast at multi-decade lows whereas Brazil will enjoy its highest on
record (past 4 decades). At 41.55 mln bales, world ending stocks is a 15-year
low but its stocks/usage is a 17-year low. (See attachment with 4 charts
displaying ending stocks.)

PRICE IMPACT/CONCLUSIONS
From more than one client and media source, I was asked on Friday “what are
they thinking” or “that is not what I am hearing, what gives” or my personal
favorite “are they using some new math I did not learn in school”, obviously a
lot of questions with some of the changes in this month’s report especially
with usage. However, as with most reports of this nature, they are not exact,
they are subject to alteration each and every month, and should be thought of
more approximations than exact numbers. The methodology used by the USDA has
been brought under more question than normal but in a year with extreme prices,
high or low, that is not unusual. As long as I have focused exclusively on
cotton, there are more years when I disagreed with their numbers than not
during the course of the year. To their credit, they do make changes well after
the fact; that may not help with either correcting prices or their trend in the
year in question which is why these numbers should not be thought of as
absolute. I suspect we will debating the aspects of this year well into 2012,
2013, etc but a change in price of the magnitude that has occurred this crop
year is going to bring its own host of problems, not the least of which is
defining final supply and demand.

Besides in the long run, the
market is trading in its “own world” and seems to be giving the USDA little, if
any, attention. Of course, we can probably say the same with other credible
sources such as Cotlook or ICAC. Even the Mar 31 planting report generated some
interest but not as much as one would have expected as old crop quickly took
back control. Once May is off the board, July and Dec will have a “battle royal”
for leadership as traders shift from tightness with old crop yet problems with
consumption vs potential weather issues and planting progress here and aboard.

As a reminder, my technician
predicted cotton would endure a major top this calendar year with highs most
likely in the first few months. Barring production issues that prevents an uber
record world crop, the highs made by the March at 2.29 or May of 2.19 could
well be not only the seasonal high but generational high. It is possible July
could trade higher depending on the outcome with the unfixed on-call positions.
Foreign mills are preoccupied with their on-call situation given the non-
profitable yarn/cloth prices, credit issues, currency fluctuations etc.
Besides, no mill wants to own any 2010/11 cotton that they did not already have
the product sold considering the 50-55 cent discount with new crop. As to how
probable is it July will make new highs, my instincts say no but that does not
rule an attempt depending on what other commodities including crude, corn,
gold, etc trade at over the next 11 weeks before July goes into its notice
period.

Note: There is talk NASS
could be subject to the budget cutting process in DC by way of eliminating the
weekly crop progress/condition report and curtailing the survey process in the
upcoming June 30 planting report. I will update more as I hear if this proves
to be the case or some lesser version. The monthly reports issued by the Census
Bureau regarding domestic cotton consumption have been subjected to this process
and barring a reprieve will be discontinued late summer.

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