Market Comments – September 6, 2018

NY futures slipped during this holiday-shortened period, as December gave up 96 points to close at 81.30 cents.

Although December closed today at its lowest level since August 15, it has remained in a tight 284-point settlement range for an 18thconsecutive session. Although the market had a flash-in-the-pan rally ahead of Tropical Storm Gordon, it quickly came off again the next session, after it became clear that the storm impact would not alter the US supply situation by much, apart from some quality deterioration perhaps.  

Macroeconomic worries are still at the center of the market’s current weakness, as the Indian rupee traded to a new record low of just under 72 INR per dollar today, which represents a drop of over 10% since April. Then there is the Indonesian Rupiah, which has lost over 9% during the same period and closed today at its lowest level since the Asian Crisis in 1998. Even the Chinese Yuan has slipped 9% over the last four months. The above currencies still pale in comparison to the Turkish Lira or Argentine Peso, which since April have dropped 60% and 85%, respectively.

In other words, we have an entirely different situation since the Northern Hemisphere crops were planted this spring, as currencies of big cotton producers like India, China, Brazil, Argentina or Turkey have all weakened substantially or in some cases even collapsed, making these countries a lot more competitive on the export front, while imports to markets like China, Turkey or Indonesia have become more expensive.

Falling currencies are often leading to severe recessions, as higher inflation coupled with tightening financial conditions are forcing these economies into a slowdown. Against this backdrop we feel that cotton consumption at the end-user level will start to suffer in many of these economies, which makes the current USDA forecast for global mill use at 127.62 million bales too optimistic. We feel that would be lucky to match the level of last season, which was at 122.74 million bales.

The current situation is eerily reminiscent of the summer of 2007, when the USDA was forecasting global mill use for 2007/08 at 127.78 million bales, up from 122.72 the year before. Even though the financial crisis didn’t fully unfold until a year later, global cotton consumption never came close to this optimistic forecast, as the 2007/08-season saw mill use drop to 119.68 million bales, only to collapse further to 107.08 million bales in the 2008/09-season.

History doesn’t repeat itself, but it often rhymes. In 2007 it was the subprime crisis that started to infect the financial system, which is today seen as the catalyst for the global financial crisis that followed in late 2008. Back then the subprime crisis was dismissed as nothing serious, with Fed Chairman Bernanke famously saying in May 2007 that ‘subprime won’t seriously hurt the economy’. Today we hear similar ‘expert’ opinions when it comes to emerging markets. As long as the US stock market is flying from record to record, not too many analysts seem to care. Again, when we flash back to October 2007, we notice that US stock market traded to a new record as well.

While the current emerging market woes are seen as a peripheral problem, we are afraid that they are slowly but surely going to work their way to the center. A lot of these trillions of dollars in cheap loans made to emerging markets are held by US and European banks, hedge funds and pension funds, and we therefore wonder how much pain there is going to be when some of the borrowers become unable to service or repay their debt?

So where do we go from here? For now there is still plenty of support underpinning the market. The 14.95 million bales in unfixed on-call sales, the Indian MSP (Minimum Support Price) and the 200-day moving average at 80.00 cents act like a dam that holds the market back. However, these emerging market problems are like cracks appearing in this dam and only time will tell whether they can be repaired or whether there will eventually be a breach.   

While the demand side looks iffy, the production side is quite promising at this point, with most crops around the globe coming in at the higher end of expectations. Unless there are some last minute setbacks as we approach harvest, we believe that the shrinking supply gap and weakening EM currencies will make it quite difficult for the market to generate any upside momentum.

For now we shall give the market the benefit of doubt and hold on to our sideways call, albeit with a very nervous eye on the emerging market situation!

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