NY futures ended the week mixed, as December managed to close unchanged at 99.50 cents, while March dropped 240 points to close at 96.48 cents.
For most of the week the market tried to work its way higher in the wake of continued strong buying by the Chinese Reserve and expectations of another strong export sales report. Even though the export numbers didn’t disappoint, the session turned into a typical “buy the rumor – sell the fact” affair, with the two front months closing limit down. Most of the blame for today’s dismal performance goes to speculators, who once again shied away from commodities due to all the negativity emanating from the European debt crisis.
US export sales of Upland and Pima cotton amounted to 646’800 running bales net, of which China took 630’200 running bales net. In addition to that there were 528’000 bales sold to China under ‘optional origin’. Total sales for the season now amount to 9.5 million statistical bales and there are another 1.3 million statistical bales in the ‘optional’ category. Shipments continue to lag behind though, with only 1.5 million bales exported at this point, which means that the backlog of outstanding commitments has now grown to around 8.0 million bales.
The global cotton situation reminds us of a game of ‘musical chairs’, with China operating the “on/off” switch. According to the latest USDA figures, the rest of the world (excluding the US) will produce a record crop of 107.6 million bales this season, surpassing the previous mark set in 2006/07 by no less than 7.0 million bales. However, mill demand in the rest of the world is expected to remain stagnant at 110.5 million bales, due to slow economic growth and man-made fiber substitution. As a result the seasonal production gap is expected to drop to just 2.8 million bales, which compares to much larger deficits of 13.3 million bales last season and 26.1 million bales two years ago.
Considering that the rest of the world is nearly self-sufficient, the US has done extremely well by filling its order books to the tune of 9.5 million bales, thanks to the fierce pace of sales earlier in the year, when mills were still fearful that the world would run out of cotton. As a result the US has entered this marketing year with a record 7.5 million bales in carry-in sales. But while the US has made great strides on the export front, its competitors around the globe, such as India, Central Asia, Brazil, Australia and the various African origins, may be left scrambling for a chair to sit on.
This situation is likely to lead to fierce competition among non-US growths, as they try to capture their fair share of this anemic market. Fortunately China has been acting as a stabilizing force by aggressively procuring some of the excess supply, both in the domestic and international markets, otherwise prices would already have come under a lot more pressure. The Chinese Reserve has so far lifted 2.7 million statistical bales in the Chinese market and probably a similar amount overseas. However, the market realizes that this Reserve buying doesn’t represent real consumption and that it is the only game in town, which is not very comforting.
Another interesting feature this week was the Dec/March spread, which saw a wild swing of over 500 points since November 8, reversing from 57 points “March over” to 490 points “Dec over” on November 15, before settling at a 302 points “Dec over” today. It is difficult to offer a good explanation for this unexpected resurgence of the inversion. Maybe it had to do with the still relatively large amount of unfixed on-call sales, as procrastinators were being rushed into last minute fixations. But there was also a rumor that at least part of the US sales to the Chinese Reserve would allow for 1.1/16-staple to be delivered. If true, it would mean that a big chunk of the certified stock, which otherwise is considered unattractive and overpriced, may have found a home.
The last recap of the certified stock, which includes about 48’000 bales, has 28’000 bales with staple 1.1/16 and longer, while about 20’000 bales are 1.1/32. Even though some of this certified stock may have found a taker, the fact that December has once again inverted so strongly above March should attract a lot more unwanted short staple cotton to the board. It will be interesting to see how the December story plays out when we head into First Notice Day next Wednesday.
As we have already alluded to, the European debt crisis was once again weighing heavily on financial markets today. The fact that both Italian and Spanish 10-year yields are hovering near 7% is like a ‘vote of no-confidence’. Investors seem to leave these riskier markets despite the high yield being offered and instead favor low-yielding German and US bonds. The European Central bank has once again stepped in and taken the place of these fleeing investors. However, the European monetary union seems to be closer than ever to a collapse and apparently Germany and France are already making contingency plans on how to proceed if the system were to melt down.
Traders continue to be torn between two scenarios when it comes to the debt crisis, which is not just a European, but a global phenomenon. On the one hand there is the treat of severe deleveraging, because the notional derivatives exposure tied to sovereign and bank debt is a gigantic house of cards. On the other hand there is the willingness by politicians and central bankers to keep the debt bubble afloat by pumping ever-increasing sums of money into it, money that is created out of thin air, which is highly inflationary. Needless to say that markets hate uncertainty and we can’t blame speculators and investors for adopting a ‘better safe than sorry’ attitude.
So where do we go from here? China is still the main supporting factor in the cotton market at the moment, but it remains to be seen whether it is potent enough to stem against a growing bearish tide. As crops are moving in and unsold supplies keep building in non-US origins, we expect to see some additional hedge selling by the trade. And since speculators are not likely to buy the market in the current environment, we should therefore see a softer market in the weeks ahead.
Best Regards
