This was one of those days where we got some long-awaited news from China that was going to surely be bearish … only to have the market jump sharply on the news instead. A very humbling experience for any analyst …

HereΆs what happened: ChinaΆs official news agency Xinhua, reported today that indeed, Beijing is going to scrap its policy of supporting domestic cotton prices by buying up domestic production at prices nearly double the cost of imported cotton. Instead, they will let domestic prices work back down to global levels, establish “target prices” for their farmers and pay deficiency payments.

With nearly 10 million tonnes of cotton already in government reserves, we and most other market analysts have long assumed that once Beijing decided to stop supporting prices and allowed these reserves back into their domestic market, import demand would suddenly plummet and global cotton prices would tank.

HOWEVER, todayΆs announcement was accompanied by other news noting that China had relaxed the standard for acceptable old-crop cotton that would still be purchased and that led to a sharp jump in Chinese cotton futures for fear of a shortage of deliverable cotton against futures contracts. Those holding short positions in cotton on ChinaΆs Zhengzhou Commodity Exchange suddenly panicked and covered shorts aggressively.

In yet another surprise, ChinaΆs Finance Minister said that should state reserves ever begin to run low, they would be replenished with imported cotton if necessary. That seems a stretch with reserves currently equal to nearly 18 months worth of Chinese mill use.

But the fact that Beijing also indicated it would be raising target prices for other crops led to some speculation that if target prices for cotton werenΆt high enough to compete with alternative crops, Chinese domestic cotton production may drop rather sharply, especially if the government opens the border to imports as market conditions dictate rather than strict quotas regulate.

This, in turn, led to a buying frenzy in U.S. cotton on ideas that imports may actually INCREASE short-term, due to shortages of quality cotton. HereΆs the weekly cotton chart after todayΆs surprise surge:

ThereΆs pretty evident overhead resistance now at fall highs around 86. But if this surprising reaction to the announcement from China can punch futures above that level, it opens up additional potential to the low 90s.