Cotton's 'excessive' bull run stalls as trade banks bumper prices

NEW YORK: Cotton's longest bull run in two years has stalled this week as merchants have sold into the speculative rally, raising doubts about how long fiber can hold above 80 cents per lb as the market struggles to digest the record global surplus.

Speculators have piled into fiber since the start of the year looking for big returns from the worst-performing commodity of the past two years and sending prices to seven-month highs of 84 cents.

The bulls point to a concentration of stock in China, the world's largest textile industry, where the state reserve is hoarding more than half the global inventory off the market.

Long-term fundamentals have also recently shown signs of improving. The United States is expected to grow its smallest crop in two decades next season as farmers sow more higher-priced grains.

But those factors are not enough to sustain prices above 80 cents as the market works through a record surplus and bumper output in the current marketing year, which ends in July, analysts have said. Even without China's massive stockpile, supplies are enough to meet consumption, they say.

"The near record net speculative length looks excessive given the lack of significant shifts in fundamentals and creates risk for a swift pullback in prices," Goldman Sachs analysts said this week in a note.

The influential Wall Street bank maintained its three-month cotton forecast of 75 cents a lb, more than 9 percent below Thursday's closing price of $82.79 cents a lb.

Capital Economics see an even greater downside potential. The London-based investment research firm projected prices will fall by more than 30 percent to 55 cents a lb by year-end, citing "excessive" stocks in China, rising competition from man-made fibers and a "subdued" macroeconomic recovery.

High prices will also further erode fabric makers' appetite for fiber in favor of lower-priced polyester.

Even while Beijing effectively holds more than half of the 2012/13 carryover off the market, brokers and physical traders agree prices will struggle to retest 84 cents per lb, its seven-month high hit on Jan. 24, while merchants sell into the rally.

"It's getting a little uncomfortable. The trade sees 83 cents as overvalued," said Ron Lawson, veteran cotton trader and a partner at commodity investment firm LOGIC Advisors.

With the spread between March and May contracts at 1.77 cents, merchants can sell forward, cover financing and storage costs and still make a profit.

BULLS V. BEARS

For funds hunting for bargains, cotton provided plenty of opportunity at the start of the year. Even after their buying spree, prices are low compared with March 2011 when they pierced $2.2 per lb, a record since the US Civil War in the 1860s.

In just five weeks, hedge funds and other speculative investors have built their largest net long position in two and a half years and have transformed the market landscape.

In January, fiber outperformed the 18 other commodities in the Thomson Reuters-Jefferies CRB Index, surging more than 10 percent.

Monthly trading volume doubled last month from December, and rose almost a third from January 2012, according to ICE data. Open interest, a measure of a market's liquidity, breached 214,000 contracts on Feb. 6, its highest in two years, although it has fallen back slightly in recent days.

But the market outlook was very different. Prices soared to records as Chinese demand was rising and crops in Texas, the main cotton-growing state in the United States, were hit by a devastating drought.

Their subsequent collapse was almost as dramatic as growers planted more cotton due to the high prices and mills cut their use of raw fiber in their blends.

That resulting surplus continues to dog the global market, making merchants hesitant to follow speculators' lead. Commercial investors were holding their biggest net short since September 2010, last Friday's data showed.

Without trade buying, which would require a big shift in fundamentals, the chance for cotton to rise much further is low.

"I don't think the trade is in a position or in the mood to come in behind the specs and get long this market," said Jordan Lea, chairman and co-owner of Eastern Trading in South Carolina.