European debt crisis may jeopardize cotton market

19 May '12

6 min read

However, while this money printing may have prevented an implosion of the debt bubble and created the illusion of renewed economic growth, the reality is quite sobering. Jobs in the industrialized world are not coming back, debt keeps rising to alarming levels and social unrest is becoming more evident.

Europe is a mess, with 11 countries in the EU either in or about to enter a recession, and even China's growth engine is starting to sputter. Although the US has its own massive problems to deal with (US government debt has increased from 9.3 to 15.7 trillion since May 2008), it still enjoys 'safe haven' status when there is trouble brewing elsewhere. As a result we have once again seen a big shift out of what are considered riskier investments, such as European debt, emerging markets and commodities, into the perceived safety of US treasuries.

Today the 10-year US bond traded at a yield of just 1.7%, approaching its historic low of 1.672% set in February 1946. It is more than a bit ironic to see yields in the world's largest debtor nation approach record lows and it speaks volumes about the irrational world we are currently living in!

Today's US export sales report was quite constructive at 180'000 running bales net for the current marketing year and 78'700 running bales for next season. This brings total commitments for the current season to 12.3 million statistical bales, whereof 9.0 million bales have so far been shipped. The buying continued to be broad-based, with 15 markets participating.

When we look at the current balance sheet for US cotton, we started with a total supply of 18.2 million bales this season, from which we need to subtract domestic mill use of 3.5 million bales and 12.3 million in export commitments.

This leaves theoretically around 2.4 million bales for sale. However, from this number we need to reserve some 0.9 million for domestic mill use between August and October, and there are also some export commitments for August/October shipment that are coming out of current crop. If we put that figure at 0.5 million bales, it would mean that there are around 1.0 million bales still for sale at this point.

This doesn't sound like much given that we are only in May, but we need to consider that we have an inverted market that is headed into a bearish oversupply situation. This means that holding on to inventory doesn't make much sense since there is neither carry available nor a positive outlook for prices. Under these circumstances it is probably best to dump any remaining cotton before it becomes burdensome.

So where do we go from here? The only bullish factor at the moment is that everyone is so bearish, which warrants some caution. However, we believe that any bounces the market may offer will be met with aggressive grower hedging and we therefore do not see much higher prices in store unless there are some problems on the weather front. Once the market approaches 70 cents we expect to see a shift in the balance of power, as growers will become more reluctant to chase prices lower, while mills should be getting more active on the buy side.

Plexus Cotton Limited

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