Plexus: NY Futures Come Under Pressure
September 18, 2012 Plexus Cotton Market Report
The market’s 3-month uptrend, which began on June 4 from a low of 64.61 cents, has finally been broken when December dropped below its uptrend line after a bearish USDA report on Wednesday. However, as was the case when the market was trying to go higher, there is not a lot of conviction behind this down move either, since we are still not seeing the necessary increase in volume and open interest that would validate an emerging trend.
There have typically been just one or two decent volume days during these moves, after which the momentum quickly fizzles in the following sessions. During Wednesday’s sell-off over 30’000 futures changed hands, but today’s volume was just half of that. The same goes for open interest, which hasn’t changed much in recent weeks, telling us that traders are simply swapping positions rather than forging a new trend. On the way up we had specs covering shorts, while the trade sold into the advance and now there seems to be some spec long liquidation, which is getting absorbed by new scale down spec and trade buying.
There has been a lot of news to digest this week, both in the world of cotton as well as on the macroeconomic front. On Wednesday the USDA surprised the market with a rather depressing 76.5 million bales global ending stocks number, which made for bearish headlines and caused a sell-off. However, as was the case with previous reports, we need to look at these numbers in greater detail in order to evaluate their potential market impact. While the numbers for China were once again quite negative, with higher beginning stocks, lower mill use and fewer imports combining for a 1.3-million bale increase in ending stocks, the situation in the rest of the world does not look quite as dire.
Production outside China actually dropped by 0.1 million bales from last month, while mill use was raised by 0.4 million bales, although projected ending stocks were still 0.5 million bales higher due to beginning stocks revisions in India and Australia. From a trade perspective we had two major exporters with crop reductions, the US (-0.54 million bales) and Brazil (-0.65 million bales), while India saw its output increase by 1.0 million bales. On balance we see the numbers outside China as neutral compared to the August report, while China itself looks more bearish. However, while China is now expected to import less than half as much cotton as it did last season, there is a strong trend towards higher yarn imports, which should mitigate the negative impact.
As long as cotton is allowed to flow into China, be it as raw cotton or in the form of yarn, it will act in support of international prices. Also, as stated last week, we do not agree with USDA’s very pessimistic global consumption numbers of 104.3 million bales for last season and 107.6 million bales for the current marketing year. We simply don’t understand why global consumption should be nearly 20 million bales below its peak in 2006/07 and feel that mill use may surprise the market in a positive manner during the course of this season.
No matter how bearish one wants to be based on cotton’s statistical situation, we cannot lose sight of what is happening on the monetary front. This week both Europe and the US wrote another important chapter in the seemingly never-ending saga of money printing. First it was the German High Court ruling in favor of the ESM (European Stability Mechanism) fund, which means that within a month there will be US$ 650 billion of additional firepower available to aid troubled European states.
Today it was the Federal Reserve’s turn, announcing an array of measures in an effort to reflate ailing asset bubbles. Apart from extending “Operation Twist” (selling short-term bonds and buying long-term bonds) until the end of this year and prolonging its zero interest policy until 2015, the Fed also announced the open-ended purchase of US$ 40 billion a month in mortgage-backed securities to prop up the depressed housing market. And if that’s not enough, Mr. Bernanke stated that the Fed would be ready to engage in additional asset purchases. Like the ECB, the Fed is now operating under the “whatever it takes” mantra.
Today’s Fed action is tantamount to a declaration of war on short sellers. We have repeatedly written about how dangerous it is to short assets in an environment where fiat money is being printed by the trillions. With central banks being as determined as they are, we have no doubt that they will succeed in inflating asset values back up to pre-crash levels and beyond. The stock market is almost there, the CRB is not far behind and the real estate market will follow suit as well. We once again need to remind ourselves of the difference between real and nominal values. While cotton priced in real terms (gold, or even crude oil for that matter) is at a historic low, it is still relatively well sustained in nominal terms and we believe that it could rise significantly over the coming years. There may still be some room to the downside when harvest pressure sets in, but going short at current levels is like trying to squeeze the last few drops out of a lemon, and the cotton market definitely qualifies as a lemon after having dropped 150 cents over the last 18 months.
So where do we go from here? We still see the possibility for the market to fall back into the 65-70 cents range when new supplies hit the market over the next couple of months, but with all the money printing that is going on, short sellers need to be quick on their feet, because eventually this tide of money is going to lift all the boats, even cotton.
The above is an opinion, and should be taken as such. Plexus cannot accept any responsibility for its accuracy or otherwise.
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