NY futures rebounded this week, with May rallying 790 points to close at 208.22 cents, while December gained 544 points to close at 132.50 cents.
This week’s volatile and somewhat unexpected move showed just how dangerous it is to trade current crop futures at the moment. Just when it seemed that May and July were starting to roll over due to waning demand on the physical front, a powerful short-covering rally lifted the spot month by as much as 2600 points between Tuesday’s low of 188.85 cents and today’s intra-day high of 115.06 cents.
Over the past three weeks traders have been steadily expanding open interest to 199’158 contracts, up from just 172’588 contracts on March 14. A big chunk of this increase came in the form of bear spreading, as traders were betting on a reversal of the steep inversion that exists all the way out to the December 2012 contract. Until a few days ago this strategy seemed to work quite well, but with May approaching its notice period, anyone short the spot month doesn’t have the luxury of time and once prices dipped below 190 cents on Tuesday, fixations and short-covering created enough outright buying to force a strong reversal.
As a result traders started to get out of bear spreads in a hurry, which forced the May/July inversion all the way out to 1900 points today, or more than 1100 points over where it had traded two days ago. The July/Dec spread, which seemed to be the main object of speculation lately, widened back out to over 5800 points today after it had narrowed in to 4700 points on Tuesday. In an effort to reign in speculation in spreading, the exchange announced this afternoon that it would raise margin requirements on spreads from 2’000 to 2’500 dollars.
US export sales followed a familiar pattern last week, whereas resistance to current crop prices led to a net reduction in sales of 15’700 running bales for the current marketing year, but commitments for next season increased by a decent 275’100 running bales. Meanwhile shipments reached a marketing year high of 539’700 running bales, bringing total export for the season so far to right around 10.0 million bales.
Outside markets may have played a helping hand in the strong showing of NY futures this week, as corn traded to an all-time high of 7.72 dollars per bushel before retreating somewhat today. Corn prices have more than doubled since last summer and are now three times what they were five to ten years ago, when they traded in a 2 to 3 dollar range year after year. With new crop corn at 6.44 dollars and new crop soybeans at 13.67 dollars a bushel, cotton has its work cut out to stay competitive.
Then there were some developments on the currency front that are worth mentioning since they are likely to have an impact on commodity markets over time. While the US is dealing with a budget crisis, Europe is currently confronted with the financial rescue of Portugal, which is in need of some 90 billion Euros to stay solvent. We have long held the belief that bailing out anyone in need, from financial institutions to entire nations, will ultimately lead to a severe debasement of the world’s leading currencies. While this may not be expressed as much in the cross rates between these two currencies, it will manifest itself in the form of higher nominal prices of just about anything from gold to cotton.
Unfortunately the governments of both the US and the European Union are either unwilling or unable to do much about their escalating debt problem. Take the ongoing US budget debate for example! Republicans and Democrats are engaged in a fierce political battle at the moment, debating whether they should cut the budget by 33 or 40 billion dollars and in what areas. However, in the end they are talking about peanuts when compared to a budget shortfall of around 1700 billion this year. In other words, it doesn’t really matter whether the national debt in the US will grow to 15’493 or 15’500 billion dollars by the end of this year. We see this as nothing more than political posturing ahead of next year’s presidential election. Meanwhile debt levels in the US, as well as in Europe, are rising at alarmingly fast rates and the only remedy left at this point seems to be the printing press. This is highly inflationary over time and we are already experiencing the first symptoms of it in the form of rising commodity prices.
So where do we go from here? While physical prices for nearby shipment are under some pressure, NY futures follow different dynamics and additional short covering has the potential to lift the May contract even higher. Unfixed on-call sales of 1.3 million bales on May and 3.2 million on July are still rather high and should keep the market well supported. However, there is no denying that May futures are currently overvalued in comparison to cash prices, probably by at least 15 cents. In other words, other than squeezing the shorts, there is little incentive for anyone to take the May contract at current prices, especially at such a steep invert to July. We therefore expect a very volatile next two weeks until the fate of the May contract gets decided. Although December got hammered today due to the unwinding of spreads, we still like it at the current level for reasons mentioned in our last report.
Best Regards
