NY futures went nowhere this week in thin pre-holiday trading, as March edged up 95 points to close at 87.24 cents.
A look at the daily trading volume says it all, as the highest turnover amounted to just 9’136 contracts. Interestingly though, many of the traders that were active added new bets, because open interest increased by around 4’000 contracts since last Thursday. Obviously there are still some traders seeking protection against further declines, but there are also some new longs entering the market.
The Chinese Reserve continued its support by taking yet another 1.0 million statistical bales of domestic cotton into its stockpile, bringing the total amount to 8.2 million bales, not counting an estimated 4.5 million bales of imports. Many observers now feel that the Reserve will lift as many as 18.0 million bales of domestic and imported cotton off the market, which would be more than the global production surplus this season.
Late last week the Chinese Ministry of Finance also announced a new formula for its sliding scale duty in 2012. It raises the threshold at which a fixed rate duty is charged from around 81 cents/lb to 100 cents/lb and increases the sliding scale duty rate below this threshold. On balance this new structure is seen as slightly supportive, because it levies a heavier tax on cheaper imports compared to 2011. So far no sliding scale import quotas have been issued, but we expect that to happen early next year.
It is not just China that is trying to support prices. The government of Pakistan is apparently intending to buy 1 million bales (of 375 lbs each) through the TCP (Trading Corporation of Pakistan) in order to help out growers and ginners. However, while the Prime Minister seems to have already instructed the Secretary of Finance to arrange the funding for such an operation, mill owners and exporters are voicing their discontent and it may therefore be a while before a final decision is reached.
While the cotton market didn’t provide a lot of excitement this week, there was a lot happening on the monetary front, as banks in Europe received an early Christmas present from the European Central Bank (ECB) two days ago. In order to preempt another liquidity crisis, the ECB offered an open-ended amount of very cheap 3-year loans to European banks. Over 500 banks jumped at this too-good-to-refuse deal, engaging in loans of around USD 636 billion, although ‘only’ about USD 270 billion will be net new loans, while the balance refinances existing debt, albeit at a cheaper rate and with a longer maturity.
This aggressive move by the ECB is tantamount to money printing, because these new loans the ECB is extending to the banking system are created out of thin air. Although this money is a lifeline for the banks, it doesn’t solve the fundamental issues, like the escalating debt bubble and massive unrecognized losses in the financial system. There is also an interesting political twist to this. While Mrs. Merkel and the Bundesbank don’t want the ECB to monetize sovereign debt, Mr. Draghi seems to circumvent this German block by lending money to the banks in order for them to buy Italian and Spanish debt. Whether that plan will work remains to be seen. After interest rates in Spain and Italy had dropped on Wednesday, they have since started to climb again.
This ECB move could prove to be significant for commodity markets because it signals to traders and hedge fund managers that the money printing game is still alive and well. This in turn could flip the investment switch to “risk on” and money may therefore flow back into the markets. Probably not during the holiday period, but we wouldn’t be surprised to see a lot of activity right after the turn of the year.
Among all the negativity in regards to global cotton consumption, which according to the USDA is now a full 10% below its peak of five years ago, we keep noticing these very strong yarn production numbers in China month after month. At the current pace Chinese mills will produce around 29.0 million tons of yarn in calendar year 2011. That’s 11.8 million tons or 68 percent more than in 2006/07. Yet Chinese mills are supposed to consume 6 million bales less cotton than they did five years ago. Did this entire increase in yarn output indeed come from man-made fibers as these statistics suggest, while cotton went the other way? Did cotton’s share in the spinning system really decline from around 63% in 2006/07 to just about 35% today? Or could China’s mill use hold a positive surprise going forward? A lot of questions, to which there are no definitive answers at this point.
So where do we go from here? Although we are still in a long-term bearish trend and there is plenty of cheap cotton looking for a home at the moment, we are mindful of the old adage ‘never short a dull market’. While this downtrend may still have some life left, we need to keep a watchful eye on potential game changers, such as declining plantings next spring, a potential rebound in demand, continuous Chinese Reserve buying that translates into substantial import quotas and Fed/ECB money printing.
One thing seems for sure - with all that’s happening on the political and macroeconomic front, it promises to be another lively and volatile year!
HAPPY HOLIDAYS!
Best Regards
