Plexus Cotton Limited reported that NY futures ended the week unchanged to slightly higher, as July gained 92 points to close at 90.72 cents, while December was up just 1 point to close at 88.31 cents.

The rapid decline in May open interest has removed the fuel for a potential short-squeeze and as a result the market was unable to sustain any upward momentum this week. As of this morning there were just some 7’000 contracts open in May, which means that the upcoming notice period will probably turn into a non-event.

The focus has now shifted to July, the new spot contract, which has inherited a big chunk of May’s open interest.

There are currently 102’712 contracts open in July, with most of the long side belonging to index funds, while the shorts are mainly owned by the trade and to a lesser degree by speculators. Since we have a disproportionately high number of shorts (10.2 million bales) compared to the amount of cotton that remains uncommitted in the US (around 2.0 million), there is still the potential for some short-covering rallies along the way.

However, since US export sales have shifted into reverse for the last three weeks and the outlook for new crop is not bullish at the moment, the shorts don’t seem to be too worried and are adopting a wait-and-see attitude.

US export sales for the week ending April 12 were once again negative with net reductions of 3’900 running bales. On the positive side there were still 17 countries buying a total of 74’100 running bales, which shows that US cotton remains an attractive alternative in many markets, but cancellations of 78’000 bales pushed the overall number into the minus column for a third consecutive week. For the season total commitments remain at around 11.8 million statistical bales, whereof 7.7 million have so far been exported. Additionally there are still 1.2 million statistical bales in ‘optional origin sales’, of which 94% are to China.

The recent string of export sales cancellations, most of which involved China, is somewhat disconcerting when we consider that half of all remaining commitments are owed to China. Of the 3.82 million running bales that are still unshipped, 1.96 million bales are for China, followed by Turkey (0.32 million bales), Mexico (0.31 million), Thailand (0.22 million) and Bangladesh (0.19 million). These five markets account for nearly 80 percent of all outstanding commitments.

China clearly holds the key in regards to the market’s next move! Will China take all of the 2 million bales of US cotton that it is still to receive this marketing year or will there be further cancellations? How about the 1.1 million bales in optional origin sales to China? What will happen to the estimated 2.5 – 3.0 million bales in consignments that are already located in Chinese ports? Are there enough import quotas left to clear all the above volume or will China suddenly shut its door? It would seem that existing quotas are about to run out, but since China’s government is still sitting on its huge reserves, it may allow more of the cheaper foreign cotton to come in via supplemental quotas.

Unfortunately we have more questions than answers at the moment, but we are keeping a keen eye on the world’s largest producer, consumer and importer.

After the USDA had raised India’s ending stocks by 1.6 million statistical bales in its April report, the Cotton Advisory Board (CAB) in India went the opposite direction this week by slashing its ending stocks number to the lowest level in 10 years due to higher exports for the current season as well as last year. While the USDA has Indian ending stocks at 9.55 million statistical bales (as of July 31), the CAB is at just 1.9 million statistical bales (as of September 30).

Although we need to allow for an adjustment since India’s marketing year ends two months later than that of the USDA, we believe that there is still a discrepancy of around 3.5 million bales between the two entities. We may therefore see a substantial downward adjustment by the USDA over the coming months, since in its April report the USDA stated that “USDA’s cotton supply and demand estimates for India rely mainly on official India data and are similar to the balance sheet of the India Cotton Advisory Board (CAB)”.

So where do we go from here? There are a lot of moving parts at the moment (China, India, planting intentions) that make it challenging to predict the market’s next move. If China continues to import rather than release some of its strategic stock, then July should remain well supported and we may even see some decent short-covering rallies. However, if China shuts its door and we see more cancellations ahead, then current crop prices will come under pressure.

The direction of new crop prices will mainly depend on how much cotton will get planted over the next couple of months and how the weather cooperates. It will take a major drop in production next season to avoid a further increase in global stocks, which is not in the cards at the moment. We therefore still lean towards the short side in December and believe that bearish options strategies are the right approach.