Thompson on Cotton: Fund Liquidation Continues Despite Positive Fundamentals

    Cotton in bloom. ©Debra L Ferguson

    Extreme volatility is nothing new to this market as it has wrestled with crop size versus demand over the past several weeks. Last week proved to be no exception with new crop futures giving up nearly nine cents in just the first two days of trading while a late week rally recouped all but a small portion of these losses.

    Alarmingly, in the process, previous support at 91.20 failed to hold as fund liquidation continued. Thus, the market closed Wednesday at 88.61, its lowest settlement since early December of last year. Fortunately, as if a shining knight coming to the rescue, strong export sales and encouraging economic news prompted a late week turnaround.

    Thursday and Friday’s triple digit gains, though unable to completely capture earlier losses, did manage to limit them to only 185 points. Considering where the week had taken us, Friday’s close of 95.63 was welcomed relief.

    Export sales for the week gave little indication of slumping demand. Combined current and new crop sales were an outstanding 425,630 bales, an increase of 344 percent over the prior week and 47 percent above the four-week average.

    New crop sales accounted for most of this at 387,400 bales with 15 different countries buying. This brings total new crop sales to 4.5 million bales compared to 2.6 million this time last year.

    Shipments of 388,350, if they can be maintained for the final five weeks of the marketing year, will allow us to meet the 14.75 million bale export estimate. Just as impressive, sales cancelations of 19,300 bales were minimal for yet another week.

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    As for the supply side of the equation, both the U.S. and world crops are getting smaller. The U.S. crop is further deteriorating with 31 percent of it rated poor to very poor while only 36 percent is considered very good to excellent. Compare this to last year’s crop which at this time was rated 10 percent and 52 percent, respectively.

    The potential shortfall now extends beyond Texas. Excessive heat and lack of moisture is taking a toll in areas of the Midsouth and Southeast where cotton is prematurely cutting out and in desperate need of rain.

    Production woes also exist globally. India, the world’s second largest cotton producing country, expects a decline in production as monsoon rains have not met expectations. Hence, their extension of duty-free imports on foreign bales until October 31 from the previous deadline of September 30.

    Despite such bullish fundamentals, it’s apparent the market is more focused on macroeconomic factors. Despite teetering on the edge of a recession, the economy is giving off mixed signals such as the addition of 372,000 jobs in June, which surpassed expectations while indicative of underlying economic activity.

    However, before getting too excited, be reminded a strong labor market historically lags other economic trends. Worse yet, it could be a double-edged sword. The Fed, intent on slowing the economy to curb inflation, will view such job strength as a plausible reason for another sizeable interest rate hike. Thereby increasing the odds of a full-blown recession.

    This week will be telling as a host of economic data is scheduled to be released certain to share additional light on inflationary pressures. The market will no doubt be watching, so prepare yourself for another roller coaster ride.

    Where to from here? The July WASDE report will be issued on Tuesday. We’ve long since learned second guessing the USDA is a no-win proposition so we’ll make no attempt to do so.

    Nonetheless, at some point, current production numbers will have to be lowered. Unless accompanied by a significant reduction in world use, which for now is not in the cards, ending stocks will bullishly decline.

    We must have faith that in time the market will revert to trading on fundamentals, which, for now, do not justify the steep selloff of the past month, a loss of over 26 cents. In this knowledge, we feel prices will return to over a dollar but hold on tight for in the process the ride will be a bumpy one.

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