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Can state cotton auction timely help cotton yarn mills?

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 Apr is traditional peak season. Cotton yarn market saw tight supply and continuous rise of price in last Apr, while at present, the market demand weakens continuously and inventory of cotton yarn mills accumulates with dropping price despite strong cotton and lower-to-negative profits. In the evening on Apr 23, Ministry of Finance announced that the state cotton auction will be launched from May 5 and end on Sep 30. Thus will the state cotton auction be timely help to cotton yarn mills to turn from deficits to profit?

From above chart it can be seen that current spot profit of cotton yarn mills stays on the negative side and the losses hit high since 2018. And profit under cotton price one month ago also tends negative gradually from Apr. Actually it does. At present, cotton yarn mills suffer losses by producing conventional carded 32/40S and gain thinner profit by producing combed and 100% bleachable cotton yarn. Apart from the losses, inventory of cotton yarn mills keeps rising and mostly hovers around 20-30 days with higher at 1.5-2 months. Amid the pressure from high inventory and losses, cotton yarn mills hardly operate and some small ones have cut or suspended production. If the weakness continues, more spinners will cut or halt production.

The state cotton auction to start on May 5 will supply cheaper cotton for cotton yarn mills, but will it help them turn deficits to profit amid current situation?

After initial calculation, the starting price of state reserved cotton with standard quality in the first week is predicted at about 15,000yuan/mt. According to the past years, the state auction was hot in early stage in 2017-2018 and the price increment was high. Average trading price of the cotton reserves was 300-1000yuan/mt lower than the starting price most of the time except for the period during which cotton yarn futures fluctuated largely, and the price spread with spot cotton ranged in 500-1,500yuan/mt and 1,000-1,500yuan/mt respectively in 2017 and 2018. Thus, average trading price is likely to be 14,000-15,000yuan/mt.

But in 2016-2018, daily sales of cotton reserves reached 30kt while in 2019, it is much lower and only 10kt. Although cotton import quotas increased and overall cotton supply was relatively adequate, the delay of cotton auction shortened the supply of low-grade and cheap cotton. As a result, high-quality cotton at high price cannot draw spinners’ attention. Fortunately, the auction is coming. In addition, traders are not banned to participate in, so the price increment during the auction is expected to be higher than previous years, especially at the early stage. That is to say, price gap between reserved cotton price and spot cotton on the market will not be wide. In general, cotton cost of cotton yarn mills will reduce to a certain extent due to poorer quality, but compared with the past years, the price will not be much lower.

On the other hand, spinners’ profit during state cotton auction stayed over 500yuan/mt theoretically in most of the time except for the period when cotton price was fiercely volatile.

Currently downstream demand remained weak. The sales in domestic market were soft and on the other hand, downstream orders and profit were scarce due to rise of dyes and rebate, gradually weakening cotton fabric and cotton yarn. As downstream tended soft gradually and some weavers have cut production without signs of improvement in short run. If the demand keeps sluggish and inventory of cotton yarn mills continues to move up, cotton yarn price will be hard to increase and sustain the weakness before the large fluctuation happens to cotton price.

The only way to make up the losses of cotton yarn mills is to lower cotton cost. Spot cotton supply at present cannot meet spinners’ requirement, so they have to turn to state reserved cotton with lower quality. According to CCFGroup, cotton yarn mills are very interested in the reserved cotton, but most of them will insist on their bottom line.

Yuan/mt Trading price of state reserved cotton Cost of cotton yarn carded 32S
Assumption 1 14000 22010
Assumption 2 14500 22560
Assumption 3 15000 23110
Assumption 4 15500 23660

As things stand, ex-works price of carded 32S prevails at 22,500-23,000yuan/mt. Due to the costs of large wastage, ex-warehouse fee, gross tolerance and freight, only cotton is traded at 15,000yuan/mt at most, can cotton yarn mills break even.

There are still some challenges to spinners. The first is capital. Limited capital can be used for state cotton auction amid tight cash flow caused by accumulated inventory and increasing downstream arrearages. The second is concerns about the quality of state reserved cotton. In case that the quality cannot meet production requirements or cause more losses, actual cost will increase despite the lower price. The last is participation of traders. If traders bid up cotton price, spinners will be burdened.

In conclusion, amid strong cotton, weak cotton yarn, widening losses and sluggish expectation of downstream market, cotton yarn mills are in urgent need of low-priced cotton to reduce cost. State reserved cotton is a good choice. However, the volumes are much less than in previous years and current supply of low-priced cotton is tight on the market. In consequence, trading price of the reserved cotton will not be too low and the price spread with spot cotton hardly reaches 1,000-1,500yuan/mt. Comparatively, cotton yarn mills can reduce cost to a certain extent by using reserved cotton whose quality is lower, and their profit can recover somewhat yet will not as high as the in previous year.

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