NY futures closed the week basically unchanged, as July edged up just 34 points to close at 61.07 cents/lb.
The market continues to be boxed in a relatively tight range, with Chinese reserve sales providing overhead resistance, while limited US supplies, unfixed on-call sales and the unwinding of basis-long positions are adding support. The July contract has now spent the last 11 sessions in a closing range of just 160 points, between 60.60 and 62.20 cents.
Tuesday’s 121-point rally proved to be nothing more than a flash in the pan, since the market promptly gave back most of its gains over the following two sessions. It was apparently a large speculative buy order, possibly linked to Chinese traders, which led to this sudden flare-up, but the trade remained unimpressed and used it to add some more short hedges.
With not much happening on the fundamental side this week, cotton seemed to take its cue from outside markets, particularly during today’s session, when a fairly decent export sales report was overshadowed by a stronger US dollar and weaker soybean and grain prices.
US export sales for the week of May 6-12 amounted to a strong 255,300 running bales of Upland and Pima cotton for both marketing years combined. Vietnam, Turkey and China led a list of 17 buyers, while shipments of 245,000 running bales went to 23 destinations. Total commitments for the season are now at 8.8 million statistical bales, just 0.2 million bales shy of the recently reduced USDA estimate, while exports amount to 6.7 million bales so far, leaving an unshipped balance of 2.1 million bales.
Some of the weakness in the various Ag markets was probably due to improved weather conditions. Weather in the Midwest and parts of the South has been erratic this spring, with wet and cold spells making it difficult for farmers to get their crops planted. However, temperatures are finally warming up and the 10-day forecast is looking favorable, which should allow for plantings to make great strides over the next couple of weeks!
Chinese reserve auctions continued to find plenty of takers, as around 1.75 million bales have so far been sold since May 3. On the one hand we have strong buying interest and a still elevated price plateau in China (ZCE/CNCE/CC-Index at around 87-88 cents), which are boding well for international prices, especially since China has recently been booking additional quantities of US, Australian and Brazilian cotton. On the other hand there is no denying that this additional supply of cotton, which had been withdrawn from the marketplace for several years, is a bearish factor in the long run. So far we have only seen the tip of the iceberg, but there are potentially tens of million bales that will get auctioned off over the coming seasons and until they are digested and global inventories return to more normal levels, it will be hard to argue for higher prices.
Having said that, we are keeping a keen eye on monetary developments, because they have the potential to turn fundamental market analysis on its head as we have learned over the last eight years. Of particular interest is the recent chatter about central banks trying to employ new methods to quasi ‘forgive’ government debt.
Although debt would not be cancelled outright, central banks could swap 10-year government bonds for 50- or 100-year bonds with a nominal interest rate of just slightly above zero. This would marginalize the debt burden and buy the frail financial system more time. Recently Belgium and Ireland have already issued some 100-year bonds and we believe that this has the potential to become the weapon of choice for major central banks as well.
In the ongoing inflation vs. deflation debate we are therefore firmly on the side of inflation. While deflationary forces clearly exist, we don’t believe that they will win out against central banks that control the printing press! For this reason we believe that we are headed for stagflation, or an inflationary recession, in which economic growth stalls, yet inflation accelerates nonetheless. In such an environment nominal commodity prices could rise regardless of fundamental factors!
So where do we go from here? Until the Index Fund roll period finally provides more liquidity, July futures should remain well supported by the 2.1 million bales in unfixed on-call sales and basis-long positions that still need to be sold, but prices are capped by the additional supply of Chinese cotton.
December and March should see some more hedging pressure as Northern Hemisphere crops emerge, which could temporarily drop values into the high 50s. We therefore continue to see the market in a trading range between 57 and 64 cents.
Central bank policy and currency rates will continue to exert their influence as well, with inflationary pressures likely to gain the upper hand over time.
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