NY cotton futures drop

17 Sep '11

5 min read

Another potential threat to the bullish case looms from Europe, where a sovereign debt crisis could trigger de-leveraging in commodity and stock markets, similar to what we saw happening in 2008. Instead of Lehman Brothers the domino will be Greece! The way this may unfold is that Greece leaves the Euro and goes back to its own currency, the Drachma. When that happens, Greek bonds denominated in Euro will be re-denominated in Drachma and bondholders will be forced to take a huge haircut via a devalued exchange rate. Greece may just be the first in a series of such spin-offs, with other peripheral nations likely to follow. Since undercapitalized and overleveraged financial institutions, such as banks, insurance companies and hedge funds, own a lot of these sovereign bonds, it would probably lead to another liquidity crisis.

There is simply way too much debt in the system, not just in Europe, but also in the US, Japan and many other economies. The market will not rest until this massive debt bubble is dealt with, which can only happen in the following three ways: 1) Strong economic growth to pay off the debt over time (not likely to happen!), 2) Massive defaults that purge the debt from the system but lead to depression for years to come (politically not acceptable!) or 3) Inflating the debt away by printing money (the most likely endgame!). In the interim we are probably faced with a hybrid of the second and third option, where defaults occur (Lehman, Greece) but are remedied by monetary intervention.

So where do we go from here? For the reasons explained above, we continue to see the market being wedged between decent support and formidable resistance, which argues for a continuation of the current sideways trend. However, we need to remain vigilant of potential forces that could trigger a breakout on either side, such as weather problems (bullish) or another financial crisis (bearish).

Plexus Cotton Limited

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