Market Comments – November 15, 2018

NY futures came under pressure this week, as March dropped 226 points to close at 78.28 cents.

The March contract, which has taken over as the lead month this week, has settled the last 43 sessions in a band of 463 points, between 76.82 and 81.45 cents. And before stepping down to the current sideways trend, March had spent 25 sessions in a 313-point closing range between 81.04 and 84.17 cents. Is the market getting ready for another move lower or will it somehow find the strength to buck this bearish trend?

What is afflicting the market, despite shrinking crops and quality issues, is the uncertainty in regards to the US/China trade conflict and the global economy. This became quite clear during the ‘Sourcing USA Summit’ in Scottsdale this week, where participants were in a gloomier mood than usual. Based on anecdotal evidence there was relatively little new business concluded when compared to previous years.

The US/China trade dispute has slowed business activity along the supply chain, as no one wants to get caught with shipments on which the tariff might suddenly increase. On September 24 a 10% tariff on USD 200 billion worth of Chinese goods was implemented, which will increase to 25% by the end of the year if no solution is found. There is also the threat of tariffs on an additional USD 267 billion if China were to retaliate. So far China has imposed or proposed tariffs on USD 110 billion on US products, which encompasses most of what the US ships to China these days.

These worries about tariffs are compounded by the threat of a global economic slowdown. After some stellar quarters of GDP growth, there are now signs that the US economy, which has been one of the main engines behind global growth, is slowing down. This has been reflected by a weakening stock market. Although the major indexes are still slightly up for the year, the majority of individual stocks is already in bear territory.

At the end of last month, 64% of the Russell 3000 stocks were down by 20% or more. Bond portfolios are in no better shape, as global bonds lost USD 1.95 trillion dollars from their January high through October. Then there are commodities, where 20 out of 22 components of the Bloomberg Commodity Index were down by more than 10% from their 52-week highs. Just look at crude oil, which has collapsed about 20 dollars/barrel since early October and is now negative for the year as well.

This negative wealth effect is starting to take a toll on consumption. Not only are portfolios shrinking, but the rising cost of money is beginning to put individuals and businesses into a choke-hold. Many analysts still feel that this is just another correction in an otherwise robust economy, but we disagree.

A couple of months ago, when we talked about the currency crisis in emerging markets, we stated that these problems on the periphery of the global economy would eventually work their way to the core and we are now starting to see evidence of that. This week it was announced that the GDP of Japan contracted at a 1.2% annualised rate in the third quarter, while that of Germany dropped by 0.8%. In China consumer spending is at a five-month low and bank lending is down.

As far as the cotton market goes, with the global economy flashing warning signs it is extremely difficult to get a good grip on where global mill use is currently at. As stated before, we don’t know of anyone who still believes the current WASDE estimate of nearly 127 million bales, but no one knows how far it has dropped. Our gut feeling tell us that it is probably somewhere between the last two seasons, when mill use amounted to 116.17 and 123.28 million bales, respectively. 

It isn’t only demand that is struggling, as the US crop continues to be hampered by wet and cold conditions, with West Texas and the Memphis territory experiencing snow this week. Only 54% of the US crop had been harvested at the beginning of the week and a prolonged dry spell is needed to get these crops off the field. We have already seen a larger than normal share of 41s and lower qualities and are afraid that this pool of discounted cotton is going to increase substantially.

Last year we had an abundance of low mike cotton and this year there will be plenty of low grade cotton available, which will depress the basis of these qualities. While this may cause losses to shippers who own this cotton at a higher cost, it should boost US exports since no one wants to hang on to these ‘hot potatoes’, while mills will appreciate the opportunity to buy discounted cotton. The fiber quality of this cotton is quite good, it has just encountered some bad weather.

So where do we go from here? When we look at the chart, we notice that March is pushing into a narrowing triangle, as defined by the primary downtrend line dating back to early June and by the cluster of early October lows. The boundaries of this triangle are currently at around 80.50 and 76.50. A break above or below these levels would likely trigger a reaction.

From a fundamental point of view the market is primarily focusing on the US/China dispute and the strength of the global economy. If there is some positive news coming out of the G-20 meeting at the end of this month and/or financial markets suddenly rebound, then cotton might spike higher, especially with the chart assisting on such a move.

However, if the trade war drags on and the global economy continues to weaken, then cotton will eventually break down to new lows. While we are pessimistic on global growth, we are hopeful that there is going to be some progress on the trade front. We therefore can’t rule out a relief rally at some point, but don’t believe that it would be long-lived.   
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