Large divergences on Chinese cotton market, how is the outlook?

Recently, ZCE cotton futures experienced significant fluctuations, with divergent views in the market. On Jul 10, influenced by weak ICE cotton futures market and negative macroeconomic sentiment, ZCE major cotton contract, Sep contract, tested previous lows, once dropping to 14,380yuan/mt. On Jul 11, cotton prices had a technical rebound following a short-term decline. However, on Jul 12, as the USDA released monthly bearish balance sheets and some ginning factories hedged their positions, ZCE cotton plummeted once again. On Jul 15, ZCE cotton rallied again. The market is currently characterized by significant fluctuations, reflecting a strong divergence of opinions between bulls and bears. Considering these market movements, what are the primary contradictions faced in the market from a fundamental perspective?

1. The sliding-scale duty quotas have not been issued (which is a expected bearish factor previously on supply side) and demand sees signs of slight improvement

Chinese cotton supply is sufficient overall, especially with a large quantity of cotton import in the first half of 2024. However, the current delay in the issuance of sliding-scale duty quotas has led to short-term less supply in circulation compared to apparent abundance in the market. Demand has been weakening since mid-Apr. Operating rate of spinning ills continues to drop and inventory keeps accumulating. Spinners and weavers are not active to replenish feedstock. But after Jul, though operating rate keeps down, the reduction slows down, and the operating rate even climbs up slightly in mid-Jul as some weavers replenish stocks in Guangdong market, and cotton yarn inventory reduces. With the upcoming traditional downstream stocking season, there is some room for imagination in the market. If downstream replenishment initiates, cotton prices may trend slightly stronger in the short term. However, the downstream improvement is not significant yet, with some cotton yarn still being sold at reduced prices, indicating a lack of strong signals from the downstream sector.

2. If the sliding-scale duty quotas are issued, both Chinese and international cotton market may be oversupplied, and seasonal demand in downstream sector remains unclear

In contrast to the Chinese cotton market, the recent performance of ICE cotton has been relatively weak compared to Chinese cotton. The abundant supply of new cotton from Brazil, the U.S., and Australia has created pressure. However, the Chinese sliding-scale duty quota has not been issued yet, leading to limited connectivity between Chinese and international markets. If the quotas are issued in the future, both Chinese and international cotton markets may face an oversupply situation. Moreover, the willingness of ginners to purchase new cotton at high prices has cooled compared to the previous year. If downstream demand for the industry fails to meet expectations for seasonal stockpiling or weakens after a certain period of stockpiling, cotton prices will continue to face strong upward pressure, with limited room for optimism.

Conclusion: in short, Chinese cotton prices are hard to decline with no allocation of sliding-scale duty quotas and the slight improvement in downstream sector. Nevertheless, if the quotas are released in the future, Chinese and international cotton market will be connected smoothly, and the cotton market may be oversupplied. If seasonal replenishment fails to meet expectations or weakens after a certain period of replenishment, cotton prices may have limited room for optimism.