Market Comments – February 21, 2019

NY futures rebounded this week, as May rallied 230 points to close at 74.01 cents/lb.

Optimism about an impending trade deal between the US and China gave the market a boost today and allowed May to close at a two-week high. However, from a longer-term perspective we are still meandering lower in a bearish trend channel dating back to early June, with the downtrend line currently at around 77 cents.

Trade negotiations between the US and China continued this week in Washington, after the two sides had met in Beijing last week. Apparently there are some MOUs (Memorandums Of Understanding) on six different subjects being drawn up, of which agriculture is one. Although there is nothing concrete on the table yet, the fact that both sides have been engaged in intense negotiations has given the market hope that a trade agreement might be reached in the near future.

Tomorrow morning the USDA is going to release a batch of six export sales reports, containing data from January 4 to February 14. The range of expectations seems to be 1.2-1.6 million bales and based on anecdotal evidence our estimate sits at the higher end. If sales were to surprise positively, then the market might extend its current move and test trendline resistance at 77 cents.

However, as stated before, we do not see the market transitioning into a new bull market at this point. There is simply too much unsold inventory around the globe while new crop plantings loom large. This will make it difficult to sustain a rally, especially since we believe that the trade is currently under-hedged.

The latest CFTC report, which provided data as of January 29, showed that speculators extended their net short position to 1.48 million bales, while the trade reduced its net short to just 5.75 million bales. A year ago the trade carried a net short that was three times larger at 17.34 million bales.

We believe that the trade will eventually have to increase its net short by several million bales as we head into the planting season. This is necessary due to risk management requirements, since we cannot imagine that lenders will allow their clients to run too large of an unhedged physical long position. Therefore, while bullish news might trigger some spec buying, the trade will likely use strength to sell into it.

In our opinion the most important piece of news this week, at least from a longer-term perspective, was the announcement by the Federal Reserve that it would stop its QT (quantitative tightening) at the end of this year, after giving in on raising interest rates a few weeks ago. Ten years ago the Fed, in addition to lowering interest rates to near zero, embarked on a massive buying spree of Mortgage-backed securities and Treasury bonds, thereby boosting its balance sheet from 0.8 to 4.5 trillion dollars.

At the time we were promised that this was just a ‘temporary move’ to inject liquidity into the system, but a decade later it sure looks like this debt monetization has become a permanent fixture. Since we believe that this monetary madness will continue and eventually get a lot worse, especially with a recession knocking at the door and government spending running rampant, the stage for ‘stagflation’ seems to be set.

For the price of cotton stagflation would bring opposing forces. On the one hand slow economic growth would suppress demand, but on the other hand the inevitable loss of purchasing power and inflation would boost the nominal value of cotton and just about everything else. Under such a scenario it becomes quite dangerous to go short, because the more liquidity central bankers are willing to inject via monetization and ultra-low rates, the faster nominal prices will rise.

So where do we go from here? Today’s flash-in-the-pan rally might continue if we get a positive surprise in tomorrow’s export sales release. However, technically were are still in a bearish trend and unless we get a move above 77 cents in May, we are going to treat this as another bear market rally. 

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