NY futures remained in a sideways trend, with December closing 117 points lower at 101.56 cents.
Although the December contract managed to expand its short-term trading range slightly to the upside this week, trading as high as 104.00 cents on Tuesday, a bearish USDA supply/demand report on Wednesday quelled any bullish hopes and likely put a firm lid on the market for the foreseeable future.
The USDA predicts global ending stocks to rise to a comfortable 54.8 million bales this season, the highest since 2008/09 and almost 10 million bales more than last season. The foreign production gap, which two years ago amounted to 26.3 million bales and set the stage for the historic bull market that followed, is currently expected to fall to just 3.0 million bales this season, the lowest since 1998/99. Since the rest of the world is basically self-sufficient this season, there won’t be a great sense of urgency to go after US cotton, especially since US export sales already amount to 8.0 million bales, which means that there will be more than enough cotton available overseas.
The bulls continue to pin their hopes on the Chinese Reserve, which seems prepared to absorb excess cotton into its strategic stock. So far only a token amount of less than 2’000 tons has been taken up by the Reserve, but the daily auction amount has been raised to 30’700 tons, which may be interpreted as an effort to make up for unsuccessful auctions in weeks past as well as having an ambitious target in regards to the total quantity the Reserve intends to procure.
Cotton is in good company when it comes to Chinese strategic reserves, since earlier this week it was rumored that Sinograin bought 1.5 million metric tons of corn as well as 0.8 million metric tons of soybeans and 0.12 million metric tons of soyoil. Traders believe that this is only the first of several large purchases by Sinograin this season. It looks as if China is trying to make good use of its large US dollar holdings.
Another potentially supportive factor for cotton and commodities in general is the vast amount of money that is currently sitting on the sidelines. M2, which measures ‘narrow’ money supply, has expanded at an 11.6 percent pace to 9.6 trillion dollars so far this year, as investors and fund managers are seeking the relative safety and liquidity of bank deposits and other assets that make up M2. According to the most recent Federal Reserve statement, the fear of a European sovereign debt crisis has prompted fund managers to bolster cash reserves in anticipation of large redemptions by investors.
Surprisingly, even though the US household sector has lost USD 8.8 trillion in net worth since 2008, it has somehow managed to increase its holdings of money-like assets and treasuries by USD 1.6 trillion to 8.3 trillion. As hedge funds and investors are hoarding money, it is being withdrawn from other asset classes as well as consumer spending. This deleveraging is similar to what happened in 2008, except this time around it is done as a pre-emptive strike. Therefore, if the crisis in Europe does not materialize or investors get the perception that things are manageable, some of this sidelined money is likely to come back into play. We got a glimpse of these dynamics earlier this week, after Mrs. Merkel and Mr. Sarkozy assured the markets that they would build a firewall around the banking system, which prompted a mini-rally in stocks and commodities.
So where do we go from here? We are not sure that the Chinese Reserve or monetary considerations are going to be enough to withstand the harvest pressure that is going to build over the coming weeks. There is still some more weather to negotiate as not all crops are safely in just yet, but if and when they are, we expect suppliers to become quite aggressive in trying to find a home for their cotton. Unlike last season, when mills were chasing after cotton, we are looking at the opposite scenario this time around. China has saved the day so far, but once its domestic crop is in and buying against pending import quotas starts to fade, the market will likely face a tougher time finding support.
From a technical point of view the market is still firmly entrenched in a sideways trend, with no discernable momentum to suggest a breakout to either side. However, we feel that over the coming months the path of least resistance is down and we also believe that the futures market will eventually swing back from inversion to contango.
Best Regards
