Rose on Cotton – Who Will Sell the Cotton Market – and When?

August 15, 2022 1:53 pm
Published by

Louis W. Rose IV and Barry B. Bean

Dec cotton gained 1246 points on the week, finishing at 108.59, with the Dec – Mar inversion expanding to 295.  Last weekend, our proprietary models predicted a finish on the week that was to be near unchanged to higher Vs the previous week’s settlement, which proved to be correct, but we did not recommend trading any bias due to Friday’s WASDE release.  It took the market about a minute to trade at limit up on Sunday evening and it remains there on Monday.

The cotton market moved higher on suspicion, and then realization, of a notable reduction in the US crop.  It was the rare case where the fact exceeded the rumor.

In its Aug WASDE report, the USDA slashed its domestic production projection 3M bales Vs July to a mere 12.5M bales, with US carryout for the new crop now projected at 1.8M bales. US abandonment is now estimated at an astonishing 43%.  At the world aggregate level, 2022/23 production, consumption and carryout were projected significantly lower at around 117.1M, 119.1M, and 82.77M bales, respectively.

While we had projected domestic production at around 14.65M bales, we are now revisiting this.  We had labeled almost all non-irrigated acreage across West Texas as destroyed, but we are now looking at abandonment on irrigated acreage.  We’ll publish our updated analysis this week.  The Sept WASDE will feature data from the USDA’s objective yield survey and updated acreage.  We will not be surprised to see production estimated a bit higher than 12.5M bales.

Most of the crop across West Texas is beyond help from further rainfall while crops in Oklahoma and Kansas still have some potential to improve.  The Mid-South crop is much improved with recent rains, but overall yields are not expected to beat a 5-year average.  Most of the crop across the southeastern states seems to be in fine condition.  Thankfully, the tropics remain mostly calm. In other news, there was no monthly increase in US inflation in July, but the annual rate was estimated at 8.5%.  While annual inflation was lower than pre-report expectations, annual inflation was already at almost 6% in July 2021, so the inflation rate is now akin to earning interest on interest.  Indeed, some economists argue that the interest rate will need to match or exceed inflation to inspire a definitive turnaround.  Readers who were in business in the 1970s and 1980s will be regaling coffee shops with tales of 20% crop and land loans.  That is all to say, things are not good despite political spin and a lowering of energy prices.  The US is in a recession.

Worth considering, though, is that unlike previous recessions, we are still dealing with a labor shortage and increasing wages being offered. Reviewing the past few recessions is useful, but they all occurred with unemployment 2-4 times higher than we are currently seeing. It is an exciting time to be an economist.

For the week ending Aug 7, the US crop was rated in 31% good, or better, condition, Vs 38% for the previous assay period and 65% Vs last season.  The condition of the Texas crop is rated in 86% fair or worse condition, with none of the crop rated in the excellent category.  Cotton is opening early across many locales, including across the Mid-south, which is troubling.

Net export sales and shipments were again disappointing.  For 2021/22 USDA-FAS has exports at approximately 13.5M 480lb bales while the WASDE estimates exports (based on customs data) at 14.65M bales.  This phenomenon has been ongoing for two consecutive years and suggests that foreign offices of major merchants are making sales of US cotton, which shows up on customs lading bills but these sales are not required to be reported in the same manner as sales made by merchants within the US.  One wonders why.

Internationally, USDA held its production estimates for the remainder of the world effectively unchanged, despite numerous reports of lower expected production in India, China, and Pakistan, among others.  In other news, Turkey is expecting to see a sharp increase in the value of its textile exports this year.  This is likely partially due to inflation, but Turkey may be a major beneficiary of the US ban on Xinjiang cotton, yarn, and textiles.

For the week ending Aug 9, the trade modestly increased its futures only net short position against all active contracts to approximately 6.17M bales while large speculators trimmed their aggregate net long position to less than 3.1M bales.  

For this week, the standard weekly technical analysis for the Dec contract remains bearish, with the market no longer oversold, while money flow is now positive.  No doubt, the analysis (and observed market action) is bullish.  There is plenty of interest on the long side of the market, but who (and when) will sell this market?  Producers will sell some cotton during this rally and some mills may buy in panic mode, which they may hedge with short futures, but we do not expect to see any massive selling to match buying interest on the horizon.  While it takes both sides to make a trade, the market can move much higher in search of significant selling. 

Producers who have been pacing the floor over missing the rally to $1.30 can sleep more soundly this week, but we struggle to embrace a short term high of much beyond the $1.20 level until we see a few days of trading the Aug WASDE numbers.  In a worst-case scenario, we believe dollar cotton is safe for the short to mid-term.  Some commentators are already throwing around $1.50+ numbers, but they drink a higher octane than we do.

Our advice for the coming week is to take advantage of the rally to get fixations up to 50% for producers who aren’t there yet, but to avoid pricing more than 60% until we get a better view of how much steam this rally has.  

Have a great weekend!

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    This post was written by Louis Rose