NY futures closed the week nearly unchanged, as March dropped just 15 points to close at 68.99 cents.
Despite another stellar export sales report this morning, it was nearly impossible for cotton futures to withstand the negative wave that has swept through global capital markets today. The sell-off in many of these outside markets has been very pronounced and broad based, as the MSCI World Stock Index fell 2.3 percent, crude oil dropped 5 percent and even gold was down by over 4 percent. Interestingly, food crops managed to buck the trend today, with corn, soybean and wheat all closing higher. Meanwhile, the Euro continued its slide against the US dollar and has now lost around 9 percent since early December.
US export sales once again beat the consensus estimate as no less than 668’800 running bales of Upland and Pima cotton were sold last week. Although 143’500 of these bales were sold for August onwards shipment, we have to assume that most of them will be supplied out of current crop. Total commitments for the season have now reached around 8.4 million statistical bales, of which some 4.5 million bales have so far been shipped. Depending on how much of the ‘new crop’ commitments will be shipped from existing supplies, we estimate that only around 6.5 to 6.8 million bales remain unsold at this point, including the certified stock.
US cotton is clearly dominating the export market at the moment, as weekly sales have averaged nearly 500’000 bales over the last four weeks for both crop years combined. This has a lot to do with the fact that the futures market has fallen more than twice as fast as the A-index, which has allowed shippers to sell their US basis-long positions ahead of foreign growths. While March futures have lost 701 points since closing at 76.00 cents on January 4th, the A-index has only dropped 325 points since posting a high of 79.85 cents on January 5th. Another factor that is motivating shippers to push US export sales, unlike in prior seasons when the AWP redemption game was being played, is that US cotton incurs carrying charges on a daily basis, whether it is in the loan or not. This has led to a sense of urgency to dispose of US inventory, while many foreign positions are contracted for forward shipments, which allows merchants to be more patient.
Despite the recent increase in the selling basis, mills have continued to buy a lot of cotton “on-call”. The latest report as of January 29 shows that while on-call sales based on the March contract have dropped by 283’500 bales net last week, unfixed on-call sales based on May and later contracts have increased by 602’900 bales net. Total unfixed on-call sales now amount to 5.22 million bales, whereof 3.44 million are on current crop March, May and July, which means that they will have to be fixed within the next four-and-a half months.
We believe that this drop in prices, which was brought about by outside forces, has rendered the fundamental picture of cotton even more bullish. To us the question is not if, but when the market will rebound and from what level? Since this will to some degree depend on what happens on the macroeconomic front, let’s take a closer look at what is currently going on in the financial markets!
Rising fear in reaction to sovereign debt problems in Europe and other parts of the world, combined with China’s hawkish stance on asset bubbles seem to have set in motion a reversal of the US dollar “carry trade”, which prompted many fund managers to exit positions in emerging markets and commodities. In a carry trade investors borrow money at very cheap interest rates and then sell the respective currency in order to invest into higher yielding assets elsewhere. For years the yen has served as the base currency for such carry trades, but since last spring traders have been doing the same with the US dollar in a fairly big way. This tends to create asset bubbles in various countries until certain events scare this flock of investors into running the other direction.
In 1998 it was Russia’s debt default and the demise of Long-Term Capital Management that created panic in global markets and forced a temporary unwinding of the yen carry trade, with the yen surging nearly 20% in just two months. This time around it is Dubai, Greece, Spain and some other culprits along with a tougher stance by the Chinese government that have caused investors to hit the rewind button. As a vast amount of money is being repatriated the US dollar rises, which in turn reinforces a negative feedback loop in stocks and commodities.
These events have caught a lot of money managers by surprise, because fundamentals have been indicating a pick-up in economic activity and the forecast for global GDP growth has been raised just a few weeks ago. Not being able to make sense of the market’s recent behavior, confused traders have decided to cash in some of their positions, among them commodities, and are moving to the sidelines until the smoke clears. However, as was the case on previous occasions, we don’t believe that this money will stay on the sidelines for very long. Also, should the current uncertainty lead to a more pronounced drop in the stock market and threaten the recovery process, we are convinced that governments and central bankers will once again come to the rescue with additional stimulus programs and quantitative easing. This in turn will heighten concerns about inflation, against which tangible assets like commodities still offer the best protection.
So where do we go from here? It is difficult to know how much longer these outside forces will influence the action in the cotton market. However, unless there is a sudden sharp drop in demand, which we do not foresee, we will be dealing with one of the tightest supply situations since 1995 as we head into spring and summer. From a technical perspective the market has so far managed to stay near the weekly uptrend line and it has also been able to bounce off of the recent 68.20 low on three occasions. While anything is possible in the short term, we remain quite friendly for the second and third quarter! Tomorrow’s NCC plantings intentions will give the market something to talk about, but no matter what this number turns out to be, it will not help to alleviate the extremely tight situation in the current marketing year. We continue to believe that the July/Dec spread offers one of the best risk/reward plays in the current environment!
Best Regards