NY futures had another mixed performance this week, but this time it was July that declined by 81 points to close at 81.28 cents, while December rallied 213 points to close at 79.08 cents.
When we look at the charts of July and December, we see two entirely different trends at the moment. While the spot month has been locked into a sideways range since the beginning of March, closing between 79.28 and 86.20 cents over the last three months, the new crop contract has been in a steady uptrend since early February and managed to break out to a new six-month high yesterday. Wednesday’s change in open interest (July down 630 contracts; December up 3’909 contracts) pretty much sums up the current market action, as July is at the beginning of its liquidating period, while December’s strong performance has been attracting new fund buying.
From a fundamental point of view the case can be made that July is more or less reflecting the true value of physical cotton, although some may still argue that the certified stock remains overpriced. Since it seems more and more likely that cash prices will be well maintained during early part of next season, December seems to be in the process of catching up to the price level of current crop.
US export sales of Upland and Pima cotton were once again excellent at 354’200 running bales for both marketing years, with over 20 markets participating. Total commitments for the current season now amount to 12.2 million statistical bales, whereof 9.0 million bales have so far been shipped, while new crop commitments now stand at 1.3 million bales. If our calculations are correct, there should be hardly any cotton left for sale outside the certified stock. Therefore, if we continue to see strong sales over the next couple of weeks, we can assume that they include certified cotton.
We feel that there is too much emphasis placed on the July/Dec inversion. Since most origins are basically sold out at this point, does it really matter whether there is carry on the board or not? As far as US cotton is concerned, since the certified stock is just about all that’s left for sale and China has an urgent need for nearby supplies, it too may disappear before July enters its notice period four weeks from now. Although we wouldn’t be surprised to see July and December meet somewhere near the 80 cents level, we don’t expect July to drop 500 points below December to reflect full carry.
The cotton market seemed mostly unfazed by the volatile outside markets this week. Uncertainty regarding the potential fallout from the European debt crisis as well as some saber rattling in North Korea had many traders pull their bets in stocks and commodities early in the week, which led to steep losses. However, just a few days later the sidelined pool of liquidity began to chase after the same assets again and a strong rebound ensued. We believe that this increased market volatility is here to stay, but we don’t foresee a global meltdown anytime soon, at least not in nominal terms.
Governments and central banks have sent a clear message to markets that they will stand by with whatever liquidity is necessary to avoid an implosion and this will sooner or later translate into inflation. Unfortunately there is not much else that can be done at this point since that debt problem has grown completely out of control. Even though markets have been focusing on Greece and some of the other European economies, the United States is actually the bigger culprit when it comes to debt. The government deficit-to-GDP ratio stands at 13.5 percent, which is higher than any European nation with the exception of Greece, while the total credit market debt-to-GDP ratio measures around 360%, which is higher than the 290% we had during the Great Depression. In our opinion it is just a matter of time until there will be a funding crisis that forces interest rates higher and the consequence from that is probably going to be stagflation. Under such a scenario prices of commodities and other tangible assets would rise in nominal terms and we therefore need to take this into account when forecasting prices over a longer period.
So where do we go from here? In the short term much will depend on China’s appetite for imports. Judging by China’s strong domestic prices and the difficult start to the Xinjiang crop we should see additional import demand over the coming weeks. Since there is not much current crop available anymore, it is still a possibility that at least part of the certified stock gets sold. Rather than focusing on spreads, we need to look at July and December in terms of their respective cash value, which is probably not too far from current levels. Since the cash market is likely to hold steady due to the tight supply situation, the futures market too should remain well supported near 80 cents.
Best Regards
