NY futures closed mixed this week, with July dropping 152 points to close at 83.30 cents, while December advanced 38 points to close at 77.57 cents.
The July contract was unable to keep its upside momentum going this week and has since slipped back below its breakout point. The weak technical performance since Monday has created a short-term top, as the market tried to push higher early on in sessions only to get rejected time after time as the day went on. The low daily volume of just 12’000 to 13’000 lots added further proof that upside momentum has been stalling.
Jittery outside markets seemed to be the momentum killer, as some speculators decided to move to the sidelines due to fears of an escalating sovereign debt crisis in Europe. Although the initial reaction by traders in uncertain times is to reduce exposure and to head for what is perceived to be a safe haven, such as US government bonds, we believe that the debt and credit problems that persist in so many economies around the globe will ultimately be quite bullish for commodity prices.
While Greece and a number of other European countries have some serious debt issues, we feel that they will not be allowed to default since that would be the beginning of the end of the European Union. German and French banks each have over 300 billion dollars in loan exposure to Greece, Spain and Portugal, while UK banks are on the hook for over 150 billion dollars. Therefore, the EU and its Central Bankers will most likely follow the same path the US has chosen, which is to use the printing press in order to escape this growing debt spiral. The inescapable consequence of all this money printing is going to be inflation, which in due time will force investors to chase after tangible assets, such as commodities.
It’s rather interesting to see US analysts and commentators harping on Europe’s debt crisis while conveniently pushing the gigantic US debt issue in the background. According to the Federal Reserve data, total US credit market debt has grown by 11.15 trillion dollars over the last four years to 52.42 trillion dollars at the end of 2009 and it now amounts to over 350% of GDP. This number doesn’t even include unfunded Social Security and Medicare liabilities, which are estimated in the tens of trillions. US public debt alone is growing at around 1.7 trillion dollars a year at the moment (12.9 trillion dollars total) and the current administration anticipates similar deficits for several years to come. That’s an increase of nearly 5 billion dollars per day - with no end in sight - but the world seems to be mesmerized with Greek’s 60 billion dollar annual budget deficit.
US export sales remained fairly strong last week at 175’200 running bales for current crop and 39’600 running bales for August onward shipment. Over the last four weeks alone the US has sold another 997’500 running bales of current crop and 151’300 bales for next marketing year (many of which will be shipped from existing stocks). For the current season we now have commitments of 11.3 million statistical bales, of which 8.0 million bales have so far been exported. Additionally there are commitments of 0.75 million bales for August onward shipment.
When we look at the latest US balance sheet, we had total supply of 18.5 million bales this season, from which 3.5 million are going to domestic mills and 11.3 million bales have so far been committed for export, leaving around 3.7 million for sale. However, we have to assume that at least 0.5 of the 0.75 million bales in export commitments for next season will come out of existing inventories and then there are probably another 0.5 million bales that domestic mills have booked for August/September delivery, which would bring the number of available bales down to just 2.7 million bales. Since the 1.0 million bales of certified stock form part of this number, there are really just about 1.7 million bales of ‘free’ bales floating around in the marketplace. And it’s only April!
The certified stock has been at the center of much debate recently, as analysts are trying to gauge what kind of an impact this large inventory of over a million bales might have on the market. Cargill, who took control of the certified stock during the March delivery, has obviously not been able to do much with it and has decided to tender it back on the May contract, while two other merchants have stepped forward to assume ownership. Although the huge inversion between July and December may seem unsustainable, we need to look past this spread when making assumptions about the fate of the certified stock.
In this tight supply situation, where the certified stock currently amounts to over 30% of what remains unsold in the US, it is no longer just a superfluous chunk of cotton whose sole purpose it is to keep speculators in check. If US export sales were to continue at their recent pace, the certified stock would make up 50% of the unsold inventory a month from now and by the time July enters its delivery period it would basically represent all the cotton that’s left for sale. We therefore need to look at the certified stock in terms of its cash market value rather than its spread to December. While NY futures at 86 cents are overvalued compared to currently available offers from the US, Africa or Brazil, it would be a different story if July were to drop to 78 or 80 cents, especially since many of these other origins won’t have a lot left to offer in two months from now. If the certified stock were to find buyers (China?) for summer shipments, then its spread to December becomes irrelevant.
So where do we go from here? Based on the chart we may see some more downside in the near term, but unless there is a mass exodus of speculators we expect strong trade support to hold the market above 82 cents. In other words, as long as there is a large trade short to cover in July (unfixed on-call sales on July are still at 2.65 million bales), we don’t expect the inversion to December to collapse in any meaningful way.
In the longer term much will depend on how new crop shapes up, but we may see a relatively firm market well into the fourth quarter. Only once the pipeline is well supplied with new crop cotton will there be a chance for prices to soften a bit, although we believe that the balance sheet will remain relatively tight throughout next season.
Best Regards
