INTELIGÊNCIA DE MERCADO SEMANAL English Edition June 22, 2015

CHINA’S COTTON CONSUMPTION EXPANDING IN XINJIANG AS SILK

ROAD PROJECT BEGINS TO UNFOLD

Western leaders often times layout grand visions which capture limited attention as they seldom result in reality; however, that is not the case in China. When Chinese leaders layout long term goals and visons they have very detailed plans developed prior to the announcement and execution will follow the announcement. The issue is the lack of transparency associated with their plans and a lack of a western understanding of what they really mean. Chinese Premier Xi Jinping in a visit to Kazakhstan in late 2013 announced the establishment of a New Silk Road Economic Belt and the event was only nominally covered by the global press. Two years later it appears to be one of the cornerstone policies of the Xi Jinping administration and the implementation of this long range program appears well underway. It is having considerable ramifications for the country’s textile and apparel sector.

At first the project appears too big to ever implement and something that would take years before the results would be realized. That is just not the case as the master plan had been established way before the announcement and various segments of the plan have already begun to unfold. The Silk Road Economic Belt will link 65 countries and 4.4 billion people and included in the project is a Maritime Silk Road component, as well. For China’s cotton and textile industry the plan appears to hold major ramifications; first, while the road begins in Xian the base of the Silk Road Economic Belt is Xinjiang. The belt will further integrate the province into the Chinese economy and force some movement of the industrial production belt westward.

The economic belt extends from Xinjiang all the way to Turkey and then to Europe making Xinjiang the gateway for the development of a new supply chain to European and Russian markets, as well as, the Middle East. Many of the major policy and economic initiatives of the last several years now appear to be linked to making this project a reality. The economic belt will have to have funds for development and the foundation for this is well underway. China set up the Asian Infrastructure Investment Bank, which now has 52 members and is expected to start lending 20 billion annually within the next 5 years which will be two thirds the average annual lending of the World Bank. China recently provided a fresh 60 billion USD in funding to its own state owned development banks.

With Xinjiang as the base of this new economic zone its stability is more important than ever and this means bringing the economic success of Eastern China to the province and region. Cotton has been an important cash crop for the most powerful company in the province, the Production and Construction Corps (PCC), the Han Chinese farmers that have moved to the region and the local Uyghur farmers. Thus, as it became apparent that China had an oversupply of cotton and the crop was no longer an economic strategic commodity China in 2014 ended most of the support for production everywhere but Xinjiang. The target price system for Xinjiang had the goal of maintaining farmer income, which can come from cotton or other products.

Within less than a year of the announcement of the new Silk Road Economic Belt the Chinese government announced in July 2014 a new 20 billion Yuan fund to assist in the development of the Xinjiang textile and apparel industry. The assistance to the textile and apparel was then extended further through a number of other measures. These eventually included a subsidy for each bale of cotton consumed in Xinjiang and other subsidies related to yarn, as well, the announcement itself also drew limited western interest. It, however, appears to be the link to a major initiative to stimulate the large Chinese textile industries to move operations to Xinjiang. The new economic corridor and the new rail link to Europe would also mean improved access to the country’s largest textile market - Europe .The development of the Silk Road Economic Zone is including a major new railway system which will give the Xinjiang exporters the ability to reach the European markets by rail.

The number of textile and apparel operations in Xinjiang is increasing rapidly under the new incentives. The new operations are not small but represent the largest and most sophisticated textile and apparel companies in China. The Shandong Ruyi Group, which operates spinning plants in Xinjiang, announced in 2014 that it would expand operations. The Rainbow Group, which owns the retail rights to many global luxury brands for China, has announced plans to establish operations in Xinjiang. The Xinjiang Zhongtai Group, the Taichang Group and Oliver Cotton Company have announced a 13.9 billion RMB new Silk Road Textile Industrial Park which will include 15 new spinning plants. The PCC has announced a new joint venture with a major textile group for the establishment a new industrial textile supply chain operation that includes cotton production, ginning, spinning, weaving and dyeing. More than 50 textile Industrial transfer projects are underway.

The transfer to Xinjiang is being driven by direct and indirect economic incentives and government policy. This combination of direct and indirect incentives, along with government policy, was the driver which transferred the majority of the textile and apparel sector from state owned enterprises to private companies that are successful, well run fully integrated operations. This very successful transformation was done with no transparent guidelines. The importance for the cotton sector is that the incentives are allowing Chinese textile groups to move domestic cotton consumption to Xinjiang and to do so at effective cotton prices on par with their counterparts in other countries. For those spinning operations outside of Xinjiang the new policies of limiting cotton imports and, at the same time, supporting cotton prices is forcing weaving and knitting operations, as well as, the integrated operations to switch to imported cotton yarns as a way to have access to competitive priced cotton. The expectation of allowing Indian mills to have duty free access for cotton yarn is accelerating the switch as spinners worry about the additional pressure from imports. However, the spinners who have established operations in Xinjiang are now able to access cotton at the same price as spinners outside China.

In Xinjiang, when all subsidies are included such as electricity, direct cotton subsidy and others, it may add up to 3,000 to 4,000 RB a ton (21.9 to 29.22 cents a lb.) of cotton consumed. Since late 2014 the domestic cotton price in China has fallen sharply with the average price of a handpicked Xinjiang T328, Middling 1 13/32, now at 13,400 to 13,400 RMB a ton, or an average of 98.24 cents. This compares to the Cotlook A Index for the same quality landed the Chinese port at 82.48 cents after being adjusted for VAT and 1% duty. The subsidies mean the spinners are having a net cotton cost of 69.00 to 76.35 cents. Now at the current time the companies have added freight cost and other cost from Xinjiang to their destination markets. The subsidies and the overall decline in Chinese prices illustrates the reasons for the rush to transfer spindles and it also would explain why these spinners would be willing to take up the Reserve stocks at the rumored floor prices. This package of incentives over multiple years may be part of a blueprint for the absorption of the Reserve stocks. At the same time the textile and apparel industry of Xinjiang has been firmly established, an increase in employment has been accomplished in Xinjiang and the companies are in place to participate in the entire Silk Road Economic Belt.

Growing cotton in China is a challenge at prices of 125.00 - 150.00 cents and below. Xinjiang is a development masterpiece having transformed one of the most hash desert environments into an agriculture powerhouse. It does have water limitations and cotton has begun to loss acreage to the food and vegetable crops that require just such an environment. The success as a tomato producer is a good example of this. As time moves forward cotton acreage in Xinjiang will switch to other crops which produce more profits. As it advances the Silk Road Economic Belt project will open up Central Asia and provide easy access for the Uzbekistan cotton, as well as, other Central Asian cotton to possibly flow into Xinjiang and altering trade routes. For China the possible 60 - 100 billion USD cost of the Reserve scheme may be a cost that it will view as worth the money if it accomplishes something as grand as the “Silk Road Economic Belt.

DETALS OF CHINA’S RESERVE SELLING EMERGES BUT NOT YET

OFFICIAL

The unofficial rumors are again strong that the Reserve will resume auctions and the floor price is unchanged from that which we discussed in detail in last week’s weekly analysis. The quantity which will be sold is rumored to now be 1.0 million tons; 400,000 tons of 2011 crop (original 300,000) at a floor price of 13,200 RMB a ton, or 96.57 cents a lb., 300,000 tons of 2012 crop (original rumors suggested 400,000) at a floor price of 14,200 RMB a ton or 103.89 cents and 300,000 tons of US imported 2011 crop cotton at a floor price of 15,000 RMB a ton or 109.40 cents a lb.

These prices compare to the current average spot price of Xinjiang 3128 of 13,400 to 13,500 RMB for handpicked cotton. The CNCE E Forward spot June contract, which is for delivery of a T229 of either hand or machine picked, is 12,186 RMB a ton. The current Cotlook A Index value of an imported Middling 1 3/32 landed the port after VAT

and 1% duty is 11,292 RMB, before the value of the quota. The price of the A Index after VAT and full 40% duty is 15,155 RMB a ton.

While these floor prices are expensive in today’s market they are sharply lower from the last Reserve’s auctions, the last 2014 auctions were near a floor price of 17,250 RMB. The 2011 crop was procured at 19,800 RMB and the 2012 and 2013 crop was procured at 20,400 RMB a ton. Under the rumored floor price the subsidy would be more than 45 cents a lb., not including 3 years of storage cost, weight loss and quality loss.

We have discussed this many times, the quality of the Reserve cotton is a big problem. At last week’s cotton conference cotton quality was a major topic as several speakers discussed how the quality had declined over the past 5 - 7 years and the decline accelerated during the time of the Reserve procurement. Staple length, uniformity and contamination are major issues.

Another issue facing the Reserve, one that will rattle the markets in the weeks and months ahead, is the need for the Reserve to rotate cotton stocks. This is something which has been done in other years, now the size of the Reserve and quality issues have made the procedure much harder to manage. In 2011 and 2012 the Reserve purchased US and other imported cotton to lower its overall cost levels, thus, the Reserve has extensive experience as a merchant. The rotation could mean that a scheme is announced to take up the portion of the 2014 domestic crop still held by ginners and traders and then sell the same volume from the Reserve stocks. It could also get back into the procurement business for the 2015 crop and then sell the older stocks to the domestic market in place of the 2015 crop. The Reserve stocks in 2016 will begin to consist of cotton which has been stored for five years and the quality is in decline and getting worse with each passing month. Therefore the rotation of stock will be essential to avoid the Reserve holding stocks which will be of limited use to its domestic industry or anyone else. Many years ago when the Reserve held stocks for extended periods of time it always had a domestic open end yarn market that was able to absorb almost any type of cotton. Today the domestic and global textile industry has upgraded and there is very limited demand for such low-grade cotton.

XINJIANG COTTON BELT AGAIN ENCOUNTERS HAIL AND RAIN STORMS

A unusual summer cold front last week brought heavy rain and hail to a large section of the Xinjiang cotton belt. The cold front brought a sharp drop in temperatures in the northern cotton areas in the valleys near the Tianshan Mountain range and in the Bavaria region. Heavy rains were also reported with up to 50 mm in the Bavaria area. The storms extended south to the very important Aksu region which was hit by large hail reported to be the size of quail eggs. The hail destroyed cotton plants stripping the plant of all leaves and also destroyed horticulture crops. Such weather systems are unusual this late in June. This storm followed early problems which affected the crop in the Aksu area. The importance of this to the marketplace outside of China is the impact which these storms will have on ELS production in the Aksu Prefecture. Aksu Prefecture is responsible for ELS production and it appears to have been affected by this and earlier storms.

US CROP; EXTREMELY WET TEXAS AND MID-SOUTH WHILE TOO

DRY CAROLINAS AND GEORGIA

The map above from Weather Bell Analytics illustrates well the weather pattern that has prevailed across the US cotton belt during the past 7 days. The weather pattern has followed very closely the pattern which has been forecast in the weather models since the season began. Texas and the eastern areas of the Mid-South have been cooler than normal and excessively wet as compared to the Carolinas and Georgia which have been under a heat wave and drier than normal. These conditions are putting the US cotton crop under stress. In the Southeast the drought and heat wave are now expected to increase with the next ten day forecast now expected to be dry and very hot, daily highs are expected to be near a 100 degrees F in most of the SE Georgia and Carolina cotton belt. The dryland crop in this area is under stress and overall the same pattern is expected over the next 45 days. Georgia is the second largest producing state in the US and the crop is both dryland and irrigated while the Carolinas are a dryland crop.

In South Texas tropical storm Bill moved onto the Texas coast on Tuesday and brought with it heavy rains and wind. The system remained intact as it moved inland producing 8 - 12 inch rains across the Coastal Bend, East Texas and lesser rainfall amounts from the Lower RGV across the eastern part of the Texas High Plains and east over eastern Louisiana, Arkansas and Missouri. In the upper Coastal Bend 10 - 13 inches of rain has

fallen with year to date rainfall amounts in many areas now exceeding total normal annual rainfall of 40 inches or more. The rains are forecast to continue through the next 3 - 5 days followed by a separate system which is moving up from Mexico to add to the moisture flow. The Rio Grande Valley, where the first cotton acreage in the US is planted, was under a flash flood watch on June 18th with 2 - 3 inch rains possible in a very short time period. The rains will continue in the region through Tuesday and the system will push up into the southern High Plains, as well.

The Coastal Bend and East Texas crop, which did get planted, is in trouble from flooded fields and standing water. The crop ratings in Monday’s USDA report already showed the stress which the Texas crop areas were in and it also showed that the cotton and soybean crops were being affected by the excessive moisture in Arkansas, Louisiana, Missouri and west TN. Arkansas and Missouri will be hit hard by tropical storm Bill as it moves northward since these areas remained wet through the weekend.

The Texas High Plains began to dry out on Monday of last week after a very wet weekend which brought unwelcome rain to the West Texas and Oklahoma cotton areas. The heaviest rainfall amounts occurred in the northern High Plains, the Rolling Plains and Oklahoma cotton districts. In the northern High Plains very heavy rainfall occurred during the June 12th – 15th time period with amounts ranging from 2 to nearly 6 inches which caused flooded fields and a great deal of standing water. The northern areas were the hardest hit. It not clear how much cotton was planted in these areas before the May 31st deadlines but any planted acreage was probably damaged with some losses. Between 2 to 6 inches of rain was reported from Hereford to Muleshoe. Muleshoe, which is northeast of Lubbock, reported 5.88 inches and Floydada, north of Lubbock, reported 3.43 inches. The heavy rains continued into the southern High Plains where Levelland, which is just west of Lubbock, received 4.59 inches, amounts declined to 1 - 2 inches to the south of Lubbock while Lubbock County reported from 2 - 4 inches or more. Flooded fields, standing water and crusting of soils will cause significant problems for the newly planted acreage. The southern High Plains had been expected to plant 2.7 - 3.0 million acres therefore the losses could be sizeable.

The other hard hit area was the northern Rolling Plains which received 4 - 6 inches from the storm while lesser amounts fell in the southern Rolling Plains. The Rolling Plains have a June 20th planting deadline and some fields were washed out in the heaviest hit areas. This region had been expected to plant close to a million acres but both the size of plantings and the condition of this crop has been affected, as well. The bulk of the area was dry from Monday forward but the eastern half of the Rolling Plains and the southern most areas of the High Plains reported scattered showers over the week. Rainfall during the next 7 day period appears to be concentrated on the western and southern areas of the High Plains with the impact of monsoon flow up through New Mexico on the west and a low pressure system on the Texas and Mexico border in the south.

US EXPORT DEMAND NOTED FROM 16 COUNTRIES FOR PROMPT SHIPMENT

16 countries were buyers of US cotton for shipment before July 31st during the week ending June 11th. Total sales of upland reached a net 52,600 running bales of upland and 10,600 of Pima. Normally the final several weeks of a season is focused on the cleaning up of sales and shipments. The major buyers were Vietnam 21,500 bales, Turkey 17,100, Malaysia 4,400, Thailand 4,200, Taiwan 3,400, Egypt 2,200 and Pakistan 2,200 bales while South Korea canceled 5,800 and China 3,100 bales. The key Pima buyers were China 2,200 bales, Pakistan 1,900, Japan 1,800 and Bangladesh 1,600 bales. Export shipments did slow to 209,000 running bales of upland and 14,000 of Pima. Even at the reduced level of shipments they were far above the level needed to meet the USDA export target. Total 2014/15 export sales have reached 11,393, 242 480 lb. bales.

2015/16 export sales reached 70,500 running bales of upland and the main buyers were Turkey 35,400 bales, Mexico 28,000 and South Korea 2,200 bales. 2015/16 export sales continue to run behind last year at 1,477,200 running bales. Pima sales during the week reached 300 bales.

BRAZIL’S HARVEST BEGINS UNDER PERFECT WEATHER

The weather across the Brazilian cotton belt is dry and the first few fields have been picked. The outlook is for a perfect harvest period as the El Nino has returned conditions to normal. The drought in the south has ended and regular rains are now occurring. The corn harvest is also underway in Mato Grosso, safrinha corn acreage in Mato Grosso was a record this season at 3.28 million hectares. The crop in the northwest region of Mato Grosso near Diamantino appears set to experience a record yield with high boll counts noted, defoliation is underway. In the central south region near Rondonopolis harvest has started while growers are still defoliating, as is the treatment for bollworm. In the central region harvest will not start till July and growers continue to have to treat for bollworm. Boll worm treatment is also underway in the Midwestern region of the state. In the north and northcentral areas of the belt defoliation and harvest is underway and the

average yield so far is about 6.875 bales per hectare. This area has a large amount of corn acreage so treatment for boll worm and caterpillars is underway.

Trade has been active this past week in the internal market in Brazil, as well as, from merchants for export. During the June 15th – 18th time period 29,012 tons were registered on the BBM in sales from producers; 7,780 tons sold from the 2013/14 crop (much of this from Bahia), 14,411 tons sold from the 2014/15 crop and 6,821 tons from the 2015/16 crop. The lack of local inventory by the domestic spinners has created strong demand at firmer prices. The CEPEA/ESALQ Index of a 41-4-35 landed the Sao Paulo mills rallied to 2.1015 Reis per lb. for spot trade on June 18th which was up from 2.0750 Reis on June 12th. The FOB Rondonopolis price rallied even more reaching 1.98 Reis per lb. which is up sharply from 1.93 on June 12th. The FOB Santos price on June 12th was 69.00 cents lb. , up from 66.00 cents on February 12th.

The CFR Asia export basis for Brazilian cotton remained under pressure as merchants and traders remained willing to discount the offering level to secure offtake. The CFR Asia basis ranged from 700 - 1100 on December for a Middling 1 1/8 for August through December shipment. The aggressive nature of prices allowed a large volume to be sold last week into Turkey at very aggressive prices. Brazilian also moved off to several Asian destinations. The basis has been driven lower by aggressive selling out of trading groups which have provided input financing and from the sharp decline in the reputation of Brazilian cotton regarding quality after the past two seasons. The discount of a Brazilian Middling 1 1/8 to US Memphis/Eastern has reached 600 points from the average offer for July shipment and 400 points from the most aggressive US offer. The discount is even larger for Memphis/Eastern offers for November and December shipment. The pressure on the Brazilian basis is actually putting pressure on the basis offers of US 2014 crop still unsold and sold under a description, the Green Card basis remains firm (better quality assurance). The Brazilian Middling 1 1/8 is selling at up to a 1200 point discount to the average offer of Australian Middling 1 5/32 which illustrates the importance of quality and just how important a strong reputation for quality can be.

INDIAN COTTON ACREAGE EXPECTED TO SWITCH TO PULSES AFTER MSP

ANNOUNCEMENT

Prime Minister Modi continues to put his stamp on India’s agriculture policy. The annual review of Minimum Support Price (MSP) levels is recommended to the government by a commission and for cotton the MSP was announced with a small 50 Rupees per quintal increase which represented a very small increase in the likely cotton lint price. The commission on MSP issues recommendations for all crops covered by the MSP. The Modi administration announced not only the recommended 50 - 75 Rupee per quintal increase in the MSP for pulses but in addition it announced a 200 Rupee per quintal bonus increase in the MSP which took the overall increase to 5 - 6% for the pulses. The Administration did this to attempt to address the deficit in domestic pulse production vs consumption. India has been a recent net importer of pulses importing 3 MMT or more from Canada and Australia.

Pulses are a major crop in India and an important source of plant protein normally grown on 25 - 26 million hectares which far exceeds that of cotton acreage. The crop is normally grown on near 11 million hectares as a summer crop with Maharashtra, Madhya Pradesh, Rajasthan the largest producing states. The crop is also grown on large blocks of acreage in Gujarat, Andhra Pradesh and Karnataka. Following the announcement of the sharply higher MSP predictions are that acreage devoted to the pulse crops will increase by 15% or more. In Maharashtra this will mean a further reduction in cotton acreage, as well as, reduced acreage in Gujarat.

Sowing of the 2015 crop has been active over the past week as light monsoon rains reached a large portion of the cotton belt.

ARGENTINE CROP PROSPECTS REDUCED

The total production from the 2015 Argentine crop is now likely to total no more than 1.1 million bales due to heavy losses from boll worm as 10-12% of the total planted acreage is expected to be abandoned due to heavy boll worm infestations. Average yields have been impacted with some areas of Chaco hard hit with loses of more than 25%. The harvest is now about 75 - 80% complete. Export offers of Argentine styles are now in circulation across several Asian markets, as well as, southern India at aggressive basis levels. The quality of the Argentine crop is always an issue and its reputation has made it the cheapest machine picked cotton in the world. SLM 1 3/32 offers are in circulation at 75 points off December, CFR Asia, for July shipment and at 100 - 150 off for 1 1/16.

ICE FUTURES END WEEK AT LOWEST LEVELS OF THE WEEK

ICE futures experienced two sided trade last week with the price range for the week established on Tuesday, June 16th when prices in the December contract experienced an outside range reversal moving from a low of 63.16 to a high of 65.16. Trading the remainder of the week was contained within that range. The July contract continued to liquidate with Open Interest falling to only 8,684 contracts after Thursday’s session with further liquidation noted on Friday. There have been little trade support for the July contract and the reason is twofold; first, the base grade of the contract, a 41-4-34, is not in demand and not in short supply. Secondly, the certificated stocks have been increasing and are made up of Middling and better grade 1 1/16 cotton and shorter staple cotton for the most part. Therefore the liquidation of July has added to the pressure on the market.

ICE prices have also been under pressure from the weakness in the CFR basis for some growths which is reflective of the continued hand to mouth buying of spinners. This cautious approach appears tied to a lack of confidence in yarn price levels which have been slightly softer in recent weeks. The removal of China as a steady buyer at certain prices, which has been the normal for the past several seasons, has increased the volatility of basis levels as merchants attempt to manage basis positions. Any move by one of the large trading groups to adjust a basis position amid such conditions is

increasing the risk for traders and adding to the fluctuations in basis levels. It has also made spinners more cautious about accumulating a position at any one basis level, even if it appears advantageous at the time to do so.

Then the market that has had to deal with the almost daily changes in the Macro Economic outlook which has become a burden for the market. Commodity prices ended last week very weak with large losses in the major commodity indexes for the week. This contributed to the managed commodity funds and the hedge funds moving to reduce long cotton positions. The US Dollar exchange rate had no universal movement, the Australian Dollar ended the week at near unchanged at .7746 per USD. The Indian Rupee was firmer at 63.56 and the Brazilian Real was higher ending the week at 3.0982 per USD. The Euro was only marginally lower for the week despite no resolution to the Greek Crisis. This past weekend is being viewed as crucial for progress on a Greek agreement with the EU and IMF, without it capital controls are likely in Greece and an unavoidable exit from the Euro and EU. Many funds appeared to square up any long positions in many of the commodity markets ahead of this risky period. Many fear the Euro Zone is approaching such a possible event with too much compliancy.

US Weather concerns ignited little buying interest as opinions were mixed as to the actual impact, we feel the US crop is 13. 5 Million Bales and declining but this is not the universal view. Instead the ruling influences were the weaker basis, slow level of export demand and the Macro influences. The selling from these influences resulted in December ending the week at 63.90 which reflects a loss for the week of 76 points. The market did break its uptrend from the lows and then closed below the uptrend which was a negative signal for any technical trader.

The impact of the Macro influences and the liquidation of July could be seen in the CFTC Commitment of Traders report for the week ending June 16. During the week the trade houses were the main buyers reducing their net short position by a net 9,664

contracts. Swap Dealers sold a net 945 contracts, the Managed Funds sold a net 2,273 contracts, Index Funds were equal sellers reducing their long position by 2,566 contracts and the small non reportable traders were the largest seller reducing their net long by 3,165 contracts. The liquidation of longs by all these groups continued in the days after the COT report coverage period ended. The poor technical close for the week suggests additional price weakness is likely in the week ahead. A close below 63.16 should be viewed as quite negative. The larger trading range remains intact.