Why ZCE cotton futures market decline?

After the National Day holiday, ZCE major cotton contract fell from a high of 17,815yuan/mt on Oct 9 to a low of 16,360yuan/mt on Oct 18, with a cumulative decline of 1,455 yuan/mt, or 8.2%. Why did ZCE cotton drop so much and so quickly after the holiday?

From May to early Oct 2023, the market has been focusing on several key supply-side factors, including the reduction in new cotton production, the level of spot inventory shortage, and expectation of Xinjiang ginners' competition for new seed cotton. On Sep 4, the increase in daily selling volume of reserved cotton to 20,000 tons dampened the speculative enthusiasm for "spot inventory shortage."  ZCE major cotton contract reached a high of 17,905yuan/mt, and then fluctuated widely at 17,000-18,000yuan/mt. From Sep 27 to Sep 28, ZCE cotton experienced another sharp increase due to the expectation of declining cotton production in Xinjiang and Xinjiang ginners' competition for new seed cotton. However, the actual situation during the National Day holiday showed that the mainstream price for machine-picked seed cotton purchased by Xinjiang ginners was around 8yuan/kg, partly higher at 8.5 yuan/kg. This price was obviously lower than market expectations. Coupled with the continuous decrease in the price of hand-picked new cotton in South Xinjiang during the National Day holiday, ZCE cotton encountered hedging resistance as soon as it opened on Oct 9 at 17,815yuan/mt. After several supply-side factors that had driven ZCE cotton in the previous period collapsed, ZCE cotton reversed its trend and started to decline from Oct 10. Furthermore, on Oct 17 and 18, there was a gradual loosening of the mentality among growers' selling price of seed cotton. On Oct 17, more ginners lowered their purchase price to 7.7-7.8yuan/kg though growers were more active to sell at 7.9-8yuan/kg, and on Oct 18, ginners continued to lower their purchase price, with quotes as low as 7.3-7.5yuan/kg (7.5-7.7 yuan/kg being the mainstream purchase price). The weakening of the marginal increase in cotton prices further contributed to the cotton hitting a post-holiday low of 16,360yuan/mt on Oct 18.

For cotton prices in late market, several factors shall be concerned.

1. Changes in growers' selling mindset and the purchase price by ginning factories

If cotton growers are willing to gradually lower the selling price, the pressure faced by ZCE cotton will become stronger. When the seed cotton price gradually decreases to a level where cotton growers do not budge, then a temporary bottom for ZCE cotton will appear. During the National Day holiday period until Oct 17, the average purchase price of machine-picked seed cotton by ginners was mostly around 7.9-8yuan/kg. Calculating based on a cotton seed price of around 3yuan/kg, the cost of new cotton for ginners is mostly at or above 18,000yuan/mt. If ZCE cotton continues to decline, the greater the gap between ZCE otton and the cost of new cotton, the less available spot cotton for downstream purchases. However, on Oct 18, the purchase price by ginners was further reduced. If the purchase price of machine-picked seed cotton is around 7.5yuan/kg, the cost of new cotton is around 17,000yuan/ton. The loosening mindset of growers also results in a continuous downward shift in hedge pressure for ZCE cotton.

2. When will downstream cotton yarn prices stop falling, and how is the marginal change in cotton yarn sales?

After the National Day holiday, cotton yarn sales were not favorable, and prices continued to decline. The profits deteriorated further before and after the holiday. Spinners in inland suffered the highest losses of nearly 3,000yuan/mt when purchasing spot cotton from Xinjiang (using imported cotton was more profitable than using Xinjiang cotton). The recent decline in ZCE cotton has allowed spinners in inland to restore profitability when purchasing Xinjiang cotton, but the loss is still around 1,500-2,000yuan/mt (cash flow loss is within 1,000yuan/mt). Therefore, if there is no significant improvement in the sales and prices of cotton yarn in the short term, ZCE cotton also lacks momentum to rebound.

3. Is there any change in the selling volume of reserved cotton after the price declines?

Currently, the daily planned selling volume of reserve cotton is still at 20,000 tons. If cotton prices continue to decline, it is necessary to observe whether the selling volume decreases. If the selling volume decreases and the progress of new cotton purchases is still slow, the level of spot cotton supply will continue to bring potential positive factors in the later stage.

Overall, after ZCE major cotton falls below 16,500yuan/mt, the gap between ZCE cotton and the current cost of new cotton by ginners continues to widen. ZCE cotton has experienced a rapid decline in the short term, making it difficult to hedge with new cotton. The liquidity of spot cotton may face potential disruptions in the later stage. However, in the short term, the driving force for cotton prices to rebound remains weak due to the downward adjustment of seed cotton purchase prices by ginners, the loosening mindset of cotton growers, the lack of improved profitability in the downstream sector, and no significant improvement in the sales of cotton yarn. The downward seed cotton purchase prices also reduce the hedge pressure faced by cotton prices when they rise. It is important to monitor the changes in the above-mentioned key factors.