NY futures went nowhere this week, as May edged up just 45 points to close at 89.67 cents, while December advanced 88 points to close at 90.88 cents.

The market continued its choppy sideways trend this week, as it remained caught between a set of bullish and bearish crosscurrents. The most bearish argument is of course the global production surplus, which is likely to extend for a third consecutive season and which may boost global ending stocks to their highest level ever at the end of next season. However, there is still a long way to go before this scenario becomes a reality. Against that we have a present situation that looks a lot more supportive, since China has been absorbing more than the global seasonal surplus into its strategic reserve, thereby creating a tight situation in the two key export markets - the US and India.

After adding another 276’400 running bales over the last two weeks, the US has now committed around 11.3 million statistical bales for export, of which around 5.3 million bales have so far been shipped. If we add domestic mill use of 3.5 million bales, the US has already committed 94% of its 15.7 million bales crop this season. Since its beginning stocks were relatively small at 2.6 million bales, the US really doesn’t have a lot of cotton left for sale at this point.

The same is the case in India, where actual export shipments have apparently reached 8.4 million local bales, with export registrations rumored to be as high as 12 million local bales. Exports of 8.4 million bales and domestic use of 26.0 million bales would add up to the estimated crop size of around 34.5 million bales, meaning that any additional exports would have to come from beginning stocks.

With the US and India fairly well committed, spinners will have to cover their needs in the second and third quarter mainly from Brazil, Argentina, Australia, Uzbekistan, Turkmenistan and various African origins. While there won’t be any shortage of cotton, some of these origins are either expensive (Australia) or are playing hard to get (Uzbekistan). The Central Asian countries still sit on an estimated 6.5 million bales for sale and their intention is therefore a key factor for global prices over the next few months.

The most positive news for commodity prices this week came from the European Central Bank, which injected another massive amount of liquidity into the European banking system on Wednesday. In its second “Long Term Refinancing Operation” (LTRO) in eleven weeks, the ECB handed out another US$ 708 billion in very cheap 3-year loans to some 800 banks all over Europe, bringing the total of these 1 percent interest loans to over US$ 1.3 trillion since December. While some of this money is refinancing existing loans at a cheaper rate, around US$ 690 billion represent new liquidity.

To put the sheer size of these two LTRO operations into perspective, the ECB has effectively increased the money supply of the Eurozone by 10% since December, by printing an extra 3’900 US dollars on behalf of every one of its citizens. Europe has now more or less matched the money printing efforts of the Federal Reserve. While the Fed has made US$ 1.85 trillion available via its two quantitative easing programs, the ECB and the Bank of England have so far created US$ 1.3 trillion and US$ 0.5 trillion, respectively.

Officially the reason for these generous loans is to stimulate the economy by providing banks with cheap money that they can lend out to businesses in the ‘real economy’. While this may be one of the motives, we believe there were other, more pressing issues forcing the ECB to act. For one, the ECB is trying to preempt a bank run by providing banks, particularly in the Mediterranean region, with enough liquidity to meet any potential withdrawal of funds by worried customers. Also, by funneling cheap money to banks, the ECB hopes that they will act as their agents and buy up sovereign debt, thereby lowering interest rates in countries like Italy and Spain. Then there is the fear that a sovereign debt default could trigger a chain reaction in the credit-default swap (bond insurance) market, leading to a ‘credit event’ that would dwarf the one in 2008. By keeping the banking system flush with liquidity, the risk of such a meltdown becomes a lot less.

However, this money creation does have unintended consequences. For one, the sheer amount of all this added liquidity is inflationary in itself, but there is also a psychological component that acts like an accelerant. When traders around the globe become convinced that the European crisis is under control, they will once again chase after riskier assets. This has already boosted global stock markets and it is starting to take hold of the commodity complex as well. As commodity prices rise, it locks Central Banks into a destructive cycle, because higher commodity prices depress demand, which in turn prompts additional stimulus, and so on. Since the deep structural problems of the economy are not being addressed through this mechanism, the system gets entrapped in stagflation, from which it will be very difficult to escape.

So where do we go from here? When we look at just the cotton market by itself, current crop prices should continue to hold up due to the relatively tight supply situation for nearby shipment, while a bearish new crop scenario should put pressure on prices in the second quarter. However, the situation is not quite that simple, because the cotton market doesn’t exist in a vacuum. With December corn at 5.67 dollars/bushel and November soybeans at 12.94 dollars/bushel, cotton is clearly falling behind in the race for acres and there is still time for growers to change their minds. In addition to that we have this ongoing debasement of currencies and the resulting threat of inflation, which point to higher, potentially much higher nominal commodity prices in the months and years to come. For this reason alone we feel that it is dangerous to get too enamored with the short side, despite the bearish statistical picture. A continuation of the sideways trend still makes the most sense to us at the moment.

Best Regards