Market Comments – January 3, 2019

NY futures continued to sell off over the holidays, as March was down another 423 points since December 20, closing today at 70.83 cents/lb. 

The holidays didn’t bring much happiness for cotton and financial markets, as the global rout continued. Since closing at 81.15 on December 5, which is less than a month ago, March has now dropped over 10 cents and it is still anyone’s guess where the bottom is going to be.

The ongoing trade dispute between the US and China, falling stock markets around the globe and a tense political climate are all causing uncertainty and fear among investors, which is prompting them to adopt a ‘risk off’ position.

This is creating a “negative wealth effect”, as trillions of dollars are vanishing from account statements. The numbers are quite staggering when we look at total US stock market capitalization over the last 10 years.

In early 2009 the US stock market was worth around 7.8 trillion dollars, but thanks to QE and historically low interest rates we saw valuations more than quadruple to 32.2 trillion dollars in 2018. Since topping out last fall, about 6 trillion dollars have been wiped out so far, but at just under 26 trillion dollars we can’t really consider the current valuation to be a bargain yet.

As consumers around the globe retrench, it is difficult to know where mill use currently sits. We never bought into the overly optimist consumption estimate of the USDA and still feel that demand is probably not much more than it was in the 16/17-season, when mills used 116.17 million bales. The market seems to prove us right, since there is no way prices would be at 70 cents if the world was consuming 125.63 million bales.

If it hadn’t been for the all the problems on the production side, who knows how much lower prices would be today. Since September global production has been scaled back by 3.3 million bales to 118.7 million bales, but this number may still be too high. For example, the USDA currently has India at 27.0 million bales, which according to our local sources is at least 1.0-1.2 million bales too optimistic.

A while back we felt that the abundance of 41-style tenderable cotton in the US, coupled with slow offtake, would eventually force carrying charges back onto the board, as it takes an incentive for someone to hold on to this large inventory of unsold 41s. Since early December the March/Dec spread has gone from an inversion of 278 points to 176 points carry, which is a swing of 454 points in less than a month.

While the March/Dec spread may have further to go, depending on how much inventory is carried into the summer months, the March/May spread is now at 144 points, which is starting to get interesting from a takers’ point of view. Another 50 points of carry and it may become tempting for someone to stand for the certified stock next month.

Due to the ongoing government shutdown in Washington, reports like the weekly export sales or the CFTC spec/hedge report are currently not being released. The way things are going it could be a while until we get these data sets again. However, from what we can gather there has been decent export offtake lately, mainly by the Indian Subcontinent, as offers for US low grades have slipped below comparable Indian styles.

So where do we go from here? The uncertainty surrounding the global financial markets continues to weigh down cotton, as traders are afraid of a substantial slowdown in demand.

However, from a fundamental point of view we feel that US cotton is becoming quite attractive at 70 cents, especially since India’s smaller crop and the MSP (Minimum Support Price) keep local values from following US prices down. The US doesn’t really face much competition this season, apart from some West African and Brazilian offers, and we therefore feel that sooner or later mills will have no other choice but to mop up these 41-styles in the US.

It may take a while until demand for these grades becomes strong enough to offset the burden of holding inventories. However, with the March/May spread getting towards full carry, it will buy traders some time and avoid panic selling. Therefore, barring a total collapse of global financial markets, we feel that cotton has value at 70 cents and we would therefore start looking at the long side, while guarding against the downside with some cheap out-of-the-money put options. 

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