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Cotton prices enter holidays lower

Wednesday’s Trading Activity – US cotton futures opened down substantially Tues evening and within an hour or two locked limit down in the front month and pulled the next two old crop months accordingly. 

Despite the US limit up close on Tues, Chinese values failed to follow-through as has been the case the past week or two and ultimately was down at the CNCE and ZCE although the CCI was up slightly. In addition, yarn prices slipped as did polyester and the combination proved to be too much for US futures after rallying 48 cents in 4 weeks basis March 11. Plus, the March cotton futures contract was extraordinarily over bought having been up an average of 362 pts in 13 of the past 17 business days with very little correction. 

With the issue of India’s imports clearer and the likelihood of additional cotton being released at some point over the next few weeks, traders are less nervous about supplies and therefore less anxious to own futures at such high price levels. Actual futures volume was a low holiday-induced 10,935 contracts with open interest down 2,001 to 200,336 with the March down the most likely due to the 1,385 EFP/EFSs from Wednesday. Cert stocks are down 3,675 to 125,134 with nothing under review.

NEWS/REPORTS/MISC US Exports – Weekly sales due mostly to purchases by China were stronger than expected with 326K bought the week ending Dec 16. Other buyers included Turkey and Thailand. Commitments have now risen to 13.88 mln running bales, 91% of the USDA equivalent estimate of 15.29 mln (15.75 mln statistical) bales. Shipments were nearly identical to the week before with 329K leaving US ports/borders headed for in descending order China, Turkey, Indonesia, Vietnam, Mexico, Colombia, Thailand and Guatemala. After 21 weeks, 3.68 mln running bales have been shipped or 24% of Washington’s target. In the remaining 31 weeks, shipments must average 375K to obtain the current projection. There were also new crop sales of 61K attributed to purchases by Thailand, Egypt and Indonesia. 2011/12 sales total 1.56 mln bales, not overly high as the mid-point of this crop year approaches.

US November Cotton Consumption – The Census Bureau released domestic consumption for the month of November (Oct 31-Nov 27) this morning with a preliminary figure of 274,042 running bales, 28,540 below October but 8,222 higher than in Nov 09. The seasonal adjustment figure for the past two months was 13,842 and 14,017 bales. After 4 months, US mills have consumed 1,214,054 running bales vs a year ago of 1,069,133, a 13.6% gain. One note though, domestic mills have been using cheaper priced cotton from the 2009 crop year in Aug/Sept and possibly some of Oct and only began consuming new crop mid-Oct forward that was purchased well before the huge run-up occurred so the stronger consumption numbers are not much of a surprise. 

However, the second half of the year should paint a much different picture for many mills that were unprepared when prices began rallying late summer and have been forced to reduce cotton usage and/or pay far more than in past years. The annualized rate for October was held steady at 3.78 mln with November a touch lower at 3.73 mln per the NCC.

US Competitiveness – The weekly A indexes, Cotlook and USDA, are up this past week with Cotlook gaining 1,156 pts rising to 180.67 whereas the USDA which reflects the 5 cheapest, was up 969 to 176.66, both of which are records. The US quotes, MOT and Memphis, which have moved from the 1 and 2 spots to 3 and 4, were up 1,340 pts to 179.60 and 180.60. Australia and Uzbekistan, the lowest and highest outside the A index rose to 171.40 and 205.60. The Adjusted World Price is up 969 pts to 159.82.

US Cotton Ginnings – As of Dec 15, ginning of the US crop had advanced to 15,132 mln running bales including upland and pima. Converting running to statistical, ginnings stand at 15.7 mln bales or 86% of NASS adjusted figure of 18.27 mln statistical bales. Classing data will be released on Monday, Dec 27 due to tomorrow’s holiday.

PRICE IMPACT/CONCLUSIONS After Wed’s limit down move my technician said “March Cotton left an island reversal top and that could mark the end of the bull trend.” If the gap on the right side is not filled, 156.70-155.94, this very bearish signal should hamper efforts by bulls while giving bears more reason to cheer. Despite the break of the past two days, the monthly close-only chart (6 days left in the month) shows a Relative Strength Reading of 91.29%, still very, very high.

Internationally, concerns remain regarding, not if, but when China will raise its interest rate, part of their plan to contain inflation. In doing so, their demand for any/all commodities may be dampened as economic growth is reined in relative to the first half of the calendar year. Since China is the growth engine not only for the Pacific Rim but for most of the world, any efforts to restrain growth have serious implications globally. In addition, cotton’s very high price continues to

weigh on yarn prices as shown by this chart from Cotlook. Although it is a week old, the recent run- up in the A index to new highs is not being reflected in yarn prices.

New Crop: With old and therefore new crop prices running up 15 of the past 21 days, my only advice has been to continue making cash sales. Although of late, I am hearing merchants are pricing off of the March 2012 if buying at all with a larger basis meaning producers are pricing 8-10 cents below the Dec 2011 price. With a setback now in place

and more likely over the next few days, I am suggesting producers consider 1 x 2 call spreads in the event the 1.00 level is taken out into and through the first half of 2011. The dry fall and winter to date across the southern US is well known although conditions have improved modestly the past week or two.

However, NOAA’s 30 and 90-day forecast for Jan 2011 and Jan-March 2011 is for more of the same, below normal precipitation. They also expect above normal temperatures unlike this month’s below normal temperatures. The Far West is enjoying far too much precipitation but that speaks well to increased federal and state water allocations for irrigation next spring/summer. If the Dec 11 is to going reflect a weather market via dry conditions in the US it should do so Q1 in 2011 as farmers are making decisions re: planting of cotton, corn, soybeans and if wheat will be allowed to be harvested in lieu of its use as a cover crop. The rest of the world will plant a lot more cotton and I continue to look for an increase of 2 mln hectares to 35.5 mln, third largest on record if realized. Hence, even if the US crop reflects much higher abandonment and average yield, cotton production from China, India and Pakistan should see an increase in area, yields or both which is why I am comfortable in making cash sales recommendations in the 90+ cent range.

As for the 1 x 2 call option recommendation, for those who understand the risk of owning a call just above the current level and being short two calls well above the current price, this trade will allow producers to capture additional upside above 1.00 for instance and help pay for that very expensive call by selling 2 calls with a strike of 135. The cost based on Wed’s close is about 200 pts ex- commissions and fees. If the Dec 11 drops further over the next week, I would drop the strike on the nearby call and possibly the much higher calls. Theoretically, if the Dec 11 trades to and then through the 1.00 level, the profit on the 1.00 call should offset the loss on the two short 130 calls. However, and this is what producers must understand with this strategy, above the 130.00 call strike level, the value of the 1 long call will no longer offset both short calls and in theory, they are short a Dec 11 futures at the 1.30 strike. These strike levels can be varied and to avoid any risk, some producers may prefer a straight call spread but the cost will be higher. As discussed by Dr Robinson in his weekly report, the odds of the next crop year reaching this year’s highs is low and I would encourage everyone to read his analysis in that regards. From my perspective is may be possible but not probable of Dec 11 trading much beyond the 1.00-1.10 level and a great deal would have to go wrong for it to trade much higher and the likelihood of two years back to back with identical issues and ending stocks remaining at such incredibly low levels in the US and World is nil.

Note: Besides US cotton futures being closed on Fri, Dec 24 in celebration of the Christmas holiday, the ICE exchange announced US cotton futures will not open Sunday evening at 9:00 PM EST rather; it will open Monday morning at 7:30 AM EST

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Sharon C Johnson, @Copyright 2010

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