New York cotton futures settle lower

03 Mar '12

6 min read

Officially the reason for these generous loans is to stimulate the economy by providing banks with cheap money that they can lend out to businesses in the 'real economy'. While this may be one of the motives, we believe there were other, more pressing issues forcing the ECB to act. For one, the ECB is trying to preempt a bank run by providing banks, particularly in the Mediterranean region, with enough liquidity to meet any potential withdrawal of funds by worried customers.

Also, by funneling cheap money to banks, the ECB hopes that they will act as their agents and buy up sovereign debt, thereby lowering interest rates in countries like Italy and Spain. Then there is the fear that a sovereign debt default could trigger a chain reaction in the credit-default swap (bond insurance) market, leading to a 'credit event' that would dwarf the one in 2008. By keeping the banking system flush with liquidity, the risk of such a meltdown becomes a lot less.

However, this money creation does have unintended consequences. For one, the sheer amount of all this added liquidity is inflationary in itself, but there is also a psychological component that acts like an accelerant. When traders around the globe become convinced that the European crisis is under control, they will once again chase after riskier assets. This has already boosted global stock markets and it is starting to take hold of the commodity complex as well.

As commodity prices rise, it locks Central Banks into a destructive cycle, because higher commodity prices depress demand, which in turn prompts additional stimulus, and so on. Since the deep structural problems of the economy are not being addressed through this mechanism, the system gets entrapped in stagflation, from which it will be very difficult to escape.

So where do we go from here? When we look at just the cotton market by itself, current crop prices should continue to hold up due to the relatively tight supply situation for nearby shipment, while a bearish new crop scenario should put pressure on prices in the second quarter. However, the situation is not quite that simple, because the cotton market doesn't exist in a vacuum.

With December corn at 5.67 dollars/bushel and November soybeans at 12.94 dollars/bushel, cotton is clearly falling behind in the race for acres and there is still time for growers to change their minds. In addition to that we have this ongoing debasement of currencies and the resulting threat of inflation, which point to higher, potentially much higher nominal commodity prices in the months and years to come.

For this reason alone we feel that it is dangerous to get too enamored with the short side, despite the bearish statistical picture. A continuation of the sideways trend still makes the most sense to us at the moment

Plexus Cotton Limited

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