What the market knew, but cotton analysts didn't

Where did many market analysts go wrong when earlier this year, they believed the risk was to the upside in the cotton market?

A lot of it has to do with the 800-pound gorilla that’s been wreaking havoc in the market for much of the new millennium — China.

Mike Stevens, with Swiss Financial Services, speaking at the Ag Market Network’s October market update, notes that early this summer, “it was widely anticipated that China would issue supplemental import licenses to their mills, which should have provided a rally as merchants lifted their hedges.

“The market consolidated nicely between 52 cents and 53 cents last month, awaiting an announcement from the Chinese, but it became increasingly nervous as China’s cotton association, Cotlook, then the International Cotton Advisory Council started making major adjustments to estimates of both the Chinese crop and their demand.

“As the market started deteriorating technically, perception of the supply demand fundamentals began to shift as well. The weekly crop condition indices reflected marked improvement in the U.S. crop, leading most to finally acknowledge that not only was the Chinese crop getting bigger but the U.S. crop was getting bigger too.

“The October report resonated with two themes, larger supply and lower demand compared with September in both in the United States and in China.”

The result of this shift was that the cotton market basis the December futures lost 486 points between the September and October USDA crop production reports, while many analysts had been convinced the market was going to eventually break out above 54 cents.

Stevens noted that today, the pace of U.S. exports “has finally begun to pick up and should continue to do so as long as the market stays below 52 cents.

“But we still can’t lose sight of the fact that for now, we’re going to be relegated to the role of residual supplier of the world’s textile industries. Most mills here and abroad are going to continue to buy on an as-needed basis because they can’t afford these carrying charge premiums on the board.”

Stevens says any attempt for the market to move back above 52 cents, “looking at the fundamentals as we know them, would probably be technical and would not have any staying power from a fundamental standpoint.

Carl Anderson, professor emeritus, Texas A&M University says he was overly optimistic about cotton prices in mid-summer, “because the numbers we were looking at that time were a lot tighter in supply and stronger in demand than the numbers we’re dealing with now. One thing I’ve learned over time is that the market is usually right.”

After it became clear that the market wasn’t doing anything significant on either side, analysts began wondering what the market knew that they didn’t. “Sure enough, when we got these October numbers from USDA, we find out that the fundamentals of world supply-demand are now in line with the price we have.”

Another weight on the market is plenty of supply in major-exporting countries.

Anderson says that with the elimination of the Step 2 competitiveness provision, producers should expect futures prices to be 8 cents to 10 cents below the A-Index and the farm price, depending on quality, to be 4 cents to 6 cents below the nearby New York futures. “For example a 58-cent A-Index with a 12-cent difference is 46 cents to the farmer.”

Anderson noted that certificated stocks are at a very high level — 750,000 bales. “That’s a very large number that can threaten this market. Speculators are holding the equivalent of 16 million bales, and are holding on their bearish attitude.”

Anderson projects cotton prices for December 2006 to trade at between 48-52 cents. “I hope it will go a little higher, but with the supply of cotton in the world, I don’t think we’re going to get the A-Index up over 60 cents. So we have to have the A-Index going up before our nearby futures go up and before our farm prices can go up.”

But prices are expected to head up next spring, barring any negative surprises from the Far East.

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