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New York cotton futures under depression

16 Jul '11

6 min read

Despite throwing trillions of dollars at the problem with an alphabet soup full of programs like TALF, TARP, QE1, QE2, 'Cash for Clunkers' or underwriting the debt of Government Sponsored Entities like Fannie May and Freddie Mac, the economy is barely showing any signs of life. This means that economic activity is much too anemic to service the rapidly expanding debt load, with total gross government debt alone surpassing 100% of GDP this year.

Once the 'economic growth' option has to be ruled out as a potential way to reign in this escalating debt, there are really only two other alternatives left. One is to default on at least part of the obligations by forcing bondholders to take a 'haircut', which would have to be followed by tough austerity measures and an economic revival. The other, more convenient option for politicians and central bankers is to simply kick the can further down the road by 'papering' the debt problem over with even more debt.

The US, Europe and Japan have all chosen this path of least resistance and are trying to inflate the debt problem away and there is every reason to believe that they will continue to do so. The consequence of this money printing is that currencies are going to lose their purchasing power or conversely that the things denominated in these currencies will rise in nominal value, since an increasing amount of liquidity is chasing a finite amount of goods. It is no coincidence that gold as well as the Swiss Franc traded to new all-time highs against the US dollar this week. It was quite interesting to compare the headline of a US paper with that of a Swiss financial publication earlier this week, whereas the US paper proclaimed "US dollar rallies against Euro", while the Swiss headline stated "Euro and US dollar crashing". It's all about relativity!

We need to consider this relativity when we look at the value of commodities. While cotton may still seem expensive in US dollar terms, it looks actually more affordable when measured in gold, Swiss Francs or some of the stronger Asian currencies. It is also getting relatively cheap compared to competing crops like corn and soybeans. December corn closed today at 6.81 dollars/bushel and November soybeans were worth 13.84 dollars/bushel, which makes cotton look undervalued.

So where do we go from here? At the moment none of the above rationale matters much, because there are still too many longs trying to dump their inventory while mills remain in hiding. As a result we will probably see the market overshoot to the downside and after breaching major support this week, it is anybody's guess where this falling knife will finally stick. Once it does, we may see a V-shaped recovery, as some of the factors we outlined above should come back into play.

Plexus Cotton Limited

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