NY futures moved slightly higher this week, as December gained 138 points to close at 99.50 cents.

After struggling through another slow week with little demand in most consuming markets, traders woke up to an unexpectedly large US export sales report this morning, with net sales of Upland and Pima cotton totaling 999’900 running bales for the current marketing year and 24’900 running bales for the 2012/13-season. If our records are correct, it was the largest weekly sales report since October 2003! Once again it was China that dominated the action by taking 997’000 running bales net, while the remaining markets saw only a marginal increase overall, as new sales of 44’900 running bales were offset by cancellations of 41’900 running bales.

US export commitments for the current marketing year now stand at 8.9 million statistical bales, of which 0.8 million were sold under ‘optional origin’. This means that sales have already reached around 79% of the latest USDA export projection of 11.3 million bales. However, shipments are still lagging considerably behind at just 1.35 million statistical bales for the season, which tempers the optimism that could otherwise be construed from this stellar pace of US sales.

Apart from apparently becoming active in the international market as well, the Chinese Reserve continued to absorb domestic cotton at a brisk pace this week by taking up another 750’000 statistical bales, bringing the total to about 1.75 million bales since mid-October. This determined action leaves little doubt that China has embarked on a mission to bolster its strategic stockpile and to support prices paid to farmers.

The cotton market has some similarities to the bond market, where the Federal Reserve and its ‘zombie banking system’ have been countering bearish fundamentals by absorbing treasuries into their balance sheets. Fighting the Fed is fruitless, as many bond traders who have shorted treasuries this year have found out, and it may be equally dangerous for bearish cotton traders to fight the Chinese government as long as it remains on its current buying spree. After today there are probably not too many traders left who doubt the effectiveness of the “Chinese put”.

While the downside seems to be limited, what would it take for the market to move higher? Apart from Chinese support there is unfortunately not a lot of positive news to report at the moment, as most mills are still singing the blues and the yarn market remains listless. The shift from cotton to man-made fibers has taken a toll on consumption and cotton has its work cut out to regain lost ground. The most recent statistics on yarn and fabric output in China reflect this shift away from cotton. According to the National Bureau of Statistics (NBS), total yarn output in China was up 16.3% year-on-year in October, while cotton fabric production was down 7.5% year-on-year, confirming that man-made fibers have been displacing cotton.

Since weak cotton fundamentals don’t make a case for higher cotton prices, any bullish impulses may have to come from macroeconomic developments! There is little doubt that the world’s financial system is in trouble. Daily headlines about escalating deficits and rising debt levels all over the globe, defaults of counties and entire countries, unemployment and a weak housing market are all depressing economic activity and have forced policy makers and central bankers into taking extraordinary measures. Money printing and a zero-interest rate policy for years to come are now the weapons of choice, something that was unthinkable just a few short years ago.

While many feel that weak economic performance will invariably translate into lower commodity prices, we don’t necessarily agree with this train of thought. Instead we believe that the weaker the economy gets, the more money the world’s central banks are going to print, which in turn will lift nominal prices of finite resources.

Then there is the price of crude oil, which in 1999, during the height of the tech bubble, was at only 11 dollars a barrel and which today, in tough economic times, costs about 10 times as much. The emergence of China and India, geopolitical issues and reckless money printing all contributed to this rise in crude oil prices. Since the price of energy factors into everything the world produces, we believe that it will be nearly impossible to see commodity prices fall unless crude oil drops first.

So where do we go from here? With China apparently willing to absorb the seasonal production surplus into its strategic stock, the market’s downside should be well contained. At the same time we don’t see a lot of upside potential either, unless there is a significant improvement in mill activity or some bullish developments on the macro front, like a weaker dollar for example. We therefore feel that the most likely course of action in the near term is a continuation of the current sideways trend.
The Dec/March spread, which inverted again today, does not make much sense to us given what’s in the certified stock. We keep hearing that some traders might be short high grades against existing commitments, but they probably won’t find what they are looking for in the certified stock, which by now has increased to about 52’000 bales (counting bales under review) of mostly undesirable qualities. We therefore still expect carryings to return to the board once the Goldman roll, options expiration and mill fixations are behind us.

Best Regards