The Rupp Report: A Lot Of Traffic In The Cotton Trade

Cotton is heavily on the move. Various information sources report that there is heavy traffic in
cotton trading. The New York futures soared this week, with March rallying 393 points to close at
72.92 cents, while December advanced 194 points to close at 72.70 cents, explains England-based
cotton trader Plexus Ltd.

Heavy Spec Liquidation

According to Plexus, the heavy spec liquidation that began in early January ended in a heavy
volume session last week, which forced March to close down at 66.62 cents. Last week alone,
speculators sold 14,135 additional futures contracts net, totaling 1.4 million bales.

Plexus estimates speculators have sold 5 million to 5.5 million bales net over the last five
weeks — most as long liquidation, but also with a slight increase in spec shorts. Plexus adds that
outside of index funds, overall spec participation is currently at its lowest level in several

Big Block Of Index Funds

A week ago, index funds were about 7.3 million bales net long, Plexus reports, adding that
“index funds are not driven by price, but by investment dollars flowing in and out of these index
products. … On the other side of this big block of index fund longs is the trade, who is probably
around 8 million bales net short at this point after covering over 6 million bales since the
beginning of the year.”

The report continues: “If the trade continues to get out of basis-long positions and mills
fix on-call sales (3.1 million bales are on March, May and July), both of which requires short
futures to be bought back, then the question remains: who will take the other side?” As Plexus
comments, index funds are passive — as currently are speculators — further adding, “With the sell
side exhausted, all that was needed was a trigger to ignite a rally into a void of selling.” The
report notes that positive signs in the outside markets and a weaker dollar, and the latest U.S.
Department of Agriculture (USDA) report triggered all sorts of buy stops.

Increased Production

According to Plexus, the surprise in the USDA report was not the increase of U.S. exports to
12 million bales and the corresponding drop in U.S. ending stocks to 3.3 million bales, but the
1.17 million-bale increase in global mill use, bringing total usage up to 115.53 million bales. “If
the USDA is correct with their consumption estimate, it means that world production will have to
increase by 12.79 million bales next season just to keep ending stocks from shrinking any further,”
the report states.

Pakistani Cotton Under Pressure

According to the Pakistan Cotton Ginners’ Association (PCGA), cotton prices reached a high
level when a futures contract deal matured at 5,500 Pakistani rupees per maund (1 maund equals
37.32 kilograms) in Shahdadpur, Sindh. The total yield for the 2009-10 crop season is 11.56 million
bales — still 3 million bales lower than market requirements.

Contracted deals with ginners totaled a record-breaking 5,200 rupees per maund. The clash of
short-term negative supply fundamentals and the outlook for reduced domestic production and a sharp
drop in 2009-10 stocks also drove cotton price volatility, PCGA reports. There will be a 3
million-bale gap in Pakistan compared with requirements of 14 million bales, as the 2009-10 season
ended with a 2.5 million-bale shortfall. The Karachi Cotton Association (KCA) also reports its spot
rate moved once again to an historically high position in Pakistan, rising 75 rupees per maund to
4,875 rupees.

The Need To Import

The textile sector will have to import a huge quantity of cotton to meet the shortfall.
Pakistan’s textile sector must bear the burden of around $800 million to import cotton from the
United States and Brazil owing to the decline in cotton yield this season. A cotton virus caused a
drop of some 20 percent in crops in the Punjab and interior region. Other factors include reduced
area under cultivation because of a shift toward sunflower and sugar cane production, and severe
weather conditions.

During the crop season, the textile sector purchased 1.05 million bales, and private-sector
commercial exporters bought 817,810 bales. Cotton inventories sold during this season totaled 10.97
million bales, and stocks remained at 953,410 bales.

Tight Stocks

“The USDA now predicts that ending stocks outside China will be no more than 33.8 million
bales by the end of the season,” Plexus reports. “This compares to 40.1 million a year ago and 42.2
million in 2007-08. … [S]tocks will be very tight by the end of July and … mills depend on
these stocks in August, September and October to tie them over to new crop.

“Plexus estimates that “the trade will most likely be a strong net buyer of current crop
futures until July expires about four months from now … . Speculators, who just fell into a
bear-trap, will also be more inclined to approach the market from the long side, while index funds
will probably remain relatively passive. Since we expect there to be an imbalance between buyers
and sellers in the second and third quarter, prices will need to rise to a level at which new
shorts can be tempted.”

The traffic is continuing.

February 16, 2010