Plexus: Harvest Season Puts NY Futures Under Pressure
As harvest begins in the northern hemisphere, the cotton market takes a bearish turn.
October 1, 2012
NY futures have trended lower last week, as December fell by 369 points to close at 71.53 cents.
With harvest in the Northern Hemisphere gaining momentum, the market finally came under some pressure this week, as prices dropped back towards the 70 cents level. In doing so, the market has now decisively broken below the medium-term uptrend that had been in force since June 4, resuming the long-term downtrend that started 18 months ago.
The physical market has remained relatively quiet, as mills were in no hurry to change their current hand-to-mouth buying strategy. With supplies increasing rapidly as crops are moving in, we expect to see a sell side imbalance over the next two or three months, which should keep a lid on prices. In other words, we once again have the technical and fundamental picture pointing in the same direction.
US export sales of Upland and Pima cotton for the week ending September 20 were about as expected at 145’100 running bales for both marketing years combined. Total commitments now amount to around 5.5 million statistical bales, whereof some 1.2 million bales have so far been shipped. Despite an apparent lack of import quotas, China remained the strongest buyer with 58’800 running bales.
Chinese buyers continue to find ways to get their hands on cheaper foreign cotton. On the one hand they are able to import cotton outside the quota system, as long as the price is below 80 cents and the full 40% tariff is paid. While that seems expensive by international standards, it is still cheaper than domestic values. On the other hand China keeps on importing large amounts of yarn, with August imports amounting to over 132’000 tons, which is a record. That’s over twice as much as in August 2011 and calculates to nearly 1.6 million tons (7.3 million bales) annualized. We expect yarn imports to grow even stronger as long as this huge gap between Chinese and international cotton prices remains.
While the short-term trend is now clearly pointing lower, we cannot lose sight of the fact that we are in a completely new economic and financial environment, which in our opinion will have bullish implications for nominal asset prices going forward, with a few notable exceptions such as bonds. Never before has the world been in a situation where all major economies are simultaneously trying to stave off a looming economic collapse by printing unprecedented amounts of money. After the ECB and the Fed announced open-ended bond buying programs recently, the Bank of Japan last week followed suit by announcing another round of QE in the amount of USD 127 billion and today it was the Bank of China with its plan to inject USD 58 billion into money markets.
Although many traders seem to conclude that a weak economy has to translate into lower asset prices, this isn’t necessarily true. If left alone, this would most certainly be the outcome, but not in economies where there is massive monetary intervention. History is full of examples in which an economy came to a grinding halt, yet prices skyrocketed. Weimar Germany of the 1920’s and more recently Zimbabwe come to mind! In fact, the weaker the economy, the higher prices tend to go, because central banks will use ever-increasing amounts of liquidity to counter deflationary forces. As more and more people catch on to the fact that the purchasing power of currencies is being diluted, they start chasing real assets in an effort to preserve wealth. Even though asset prices may fall in real terms, they keep rising in nominal terms!
The latest quarterly ‘Flow of Funds’ numbers as reported by the Fed paint an interesting picture in that regard. The balance sheet of ‘Households’ has seen a vast improvement, as total net worth has jumped by around USD 9.2 trillion to USD 62.7 trillion since 2008 and is now just around USD 3.3 trillion below its all-time high of 2007.
Assets have increased by USD 8.5 trillion thanks to an increase in financial assets (stocks, bonds etc), while liabilities were lowered by USD 0.7 trillion, mainly due to a USD 900 billion drop in mortgage debt, as households were able to refinance into lower rates. This in turn has freed up some spending power to buy other stuff, as evidenced by the USD 200 billion increase in consumer credit, with the last two quarters showing growth rates of around 6 percent each. In other words, the Fed’s ‘reflation’ effort seems to be working and we expect this trend towards higher asset prices to continue, with the real estate market likely to provide the next boost.
The above mentioned jump in consumer credit and the fact that US retail sales at clothing stores are 17% higher for the first seven months of 2012 compared to the same period in 2009, leads us to question the very pessimistic outlook on global mill use by some prominent institutions. We believe that the sharp reduction in Chinese mill consumption, with which we agree, may have thrown off some analysts, because it is difficult to detect improvements in other markets. We are not suggesting that global mill use hasn’t suffered over the last couple of seasons, but not to the degree it is portrayed in the most recent statistics. Are we really 14 million bales lower than in 2009/10 and nearly 20 million bales below 2006/07?
So where do we go from here? The near-term trend is lower and we would not be surprised to see the market slip towards the mid-60s over the next couple of months. In the longer term we remain more optimistic due to the expected acreage shift to food crops, money printing by central banks and a potentially positive surprise in mill consumption.
The preceding is an opinion and should be taken as such. Plexus cannot accept any responsibility for its accuracy or otherwise.