NY futures retreated this week, as March dropped 123 points to close at 73.14 cents/lb.
Although the market gave back some of last week’s gains, March managed to stay in the upper half of the 354-point settlement range it has occupied for the last 5 weeks. While we see continued strong support from the cash side near 72-73 cents, the market is still looking for a reason to break out to the upside.
Bulls are getting impatient and want a quick resolution to the US/China trade dispute in order to ignite the market, but we believe that the most bullish development in the long run would be for prices to stay in the low 70s for a while longer. There is an old saying “the longer the base – the deeper in space” and we feel that this applies to the current cotton market as well.
After falling from the 80 cents level in mid-December, US export sales have picked up significantly from what we can gather. Attractive prices, a good mix of qualities on offer and a lack of competition have boosted US export sales to Pakistan, India, Turkey and various Far Eastern markets. Although we have had no data for the last six weeks, we believe that the market will be positively surprised by the net addition to commitments once the reports resume.
Since there isn’t currently much news on the cotton front, let’s take a look at the US dollar, which typically is in an inverse relationship with commodities. Analysts seems to have a wide range of opinions at the moment when it comes to the greenback, with some calling for a weaker dollar going forward, while others believe that it could get a lot stronger.
The case for a weaker US dollar focuses mainly on monetary policy and interest rate differentials. Last year the Fed was the only central bank that embarked on a course of ‘Quantitative Tightening’ (QT), but recent stock market jitters and the outlook for weaker US and global growth seem to force the Fed back into a more neutral or even dovish stance.
And if GDP continues to slip over the next few quarters, as we believe it will, then the Fed would likely be pushed towards a more accommodative monetary policy again, which would mean lower rates and possibly a resumption of ‘Quantitative Easing’ (QE). Under such a scenario the current interest rate spread vis-à-vis other currencies would narrow and thereby weaken the US dollar.
Proponents of a stronger dollar theory point to a structural shortage, as demand for US dollars currently exceeds supply. Since the US dollar is still the world’s reserve currency and by far the most dominant global funding currency, the US needs to ‘export’ dollars to the rest of the world in order to facilitate global trade or interest payments on non-US based dollar debt. But recent US policies, repatriation, QT, rising domestic funding needs, favorable interest rate spreads and safe haven considerations have been sucking a lot of the dollars away from the global system, thereby ‘starving’ the world of dollars. This has led to a strengthening greenback, especially against emerging market currencies as we have seen last year.
While a more dovish Fed could lead to temporary dollar weakness, we are afraid that the structural argument might prevail over the long run. There is simply no viable alternative to the US dollar at this point and the US might therefore continue to act as a ‘black hole’ to capital flows.
So where do we go from here? The longer US cotton remains attractively priced, the more cotton will get pushed into export channels, which will eventually tighten the balance sheet to a point at which price rationing starts to occur. We are not quite there yet, but another month or two of strong sales would probably do the trick. Once export sales reports resume, there could be an ‘awe effect’ that might lead to a positive market reaction.
Other than another downturn in global financial markets we don’t see how the current lows could be broken and therefore feel quite comfortable with support at around 72 cents. While a move to the upside seems to have the better odds, there are certainly some obstacle to overcome, such as ample stock levels, higher new crop plantings, a potential economic slowdown and a strong US dollar.
For these reasons we believe that the market will remain range bound between 72-77 cents in the foreseeable future.
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