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NY cotton market comes under renewed pressure
08
Jul '11
NY futures came under renewed pressure this week, as December fell 507 points to close at 113.52 cents.

The bearish mood in the market prevailed, as traders remain fearful that the drop in demand may more than offset US crop reductions. Mill demand continues to be only of sporadic nature and certainly not sufficient to absorb all the foreign stocks that merchants and growers would like to get rid of.

The huge inversion between July and December, which at one point back in March had widened to as much as 90 cents and only briefly traded below 20 cents a few weeks back, deserves at least part of the blame for the comatose market we are currently experiencing. As long as the market went up and mills were chasing after cotton, basis-long positions were fine because the basis was strengthening. The only issue was the availability of credit to pay for margin calls, which prompted some merchants to lift short hedges, thereby exacerbating the up move.

However, once the tide started to turn, owners of physical longs would suddenly find themselves greatly exposed, because there were hardly any buyers in the cash market, while the futures market proved to be a less than perfect hedge due to the steep inversion.

For example, even if a merchant would have been smart enough to anticipate the turn at the top and to hedge his long position by selling July futures a few months back, he would still have to give up 20, 30 or more cents in roll losses to transfer his short hedge to December a few weeks ago - a huge difference he would never be able to make up unless the basis were to strengthen substantially.

Realizing this predicament, physical longs were suddenly offering aggressively, but with only a few buyers not too many longs were able to escape. This sequence of events has turned into a downward spiral with apparently no end in sight.

There is a striking difference when we compare the balance sheets of the US and the rest of the world. The US is actually in a deficit situation, which is why the certified stock was able to find a strong taker in the last two delivery periods despite the relatively high price. Here is the latest snapshot for the US (in million statistical bales):

• Total supply on August 1, 2010: 21.0
• Exports until June 30, 2011: -13.8
• Domestic mill use until June 30: -3.5
• Unshipped/unused inventory:3.7

Against this inventory, we have the following export commitments and domestic mills requirements:

• Outstanding exports 2010/11: 1.5
• Domestic mill use July-0ct: 1.3
• Outstanding exports 2011/12: 6.0

The 1.5 million bales in current crop export commitments and the 1.3 million bales that domestic mills require until October are fairly solid numbers, although they may get somewhat reduced by additional cancellations. What's more difficult to assess is how many of the 6.0 million bales in export commitments for the 2011/12 season are for the July to October shipment period.

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