Cotton trade now operates under much tighter credit

06 Mar '09

6 min read

The trade net short position now amounts to only 4.8 mio bales, which is down an astonishing 19.0 mio bales from exactly a year ago! Speculators, which were 9.2 mio bales net long twelve months ago, have since shifted to a 1.1 mio bales net short position. Index fund positions have been cut in half compared to last year and now amount to just 6.2 mio bales net long, although there has been relatively little change in that position over the last four or five months.

The main reason for this big contraction of the trade's position is the changed monetary and economic environment we are living in. The cotton trade has been badly bruised over the last twelve months and now operates under much tighter credit. Combined with a very uncertain future this has greatly reduced the amount of forward cash positions and along with it, the need for hedging.

Whereas a year ago merchants would engage in forward contracting of several crop years ahead, the vast majority of business nowadays is for nearby shipments only. With everyone playing his cards so close to his chest, the potential for a big market move increases, should an unforeseen event occur, hence the still relatively high volatility readings.

So where do we go from here? It seems to be almost a foregone conclusion that the market will test the 40 cents support level over the next few sessions. Once this major support is reached, there are both fundamental and technical reasons to expect a rebound.

For one, we should see a lot of mill fixations and additional cash purchases around this psychological level and as we have already mentioned, it is unlikely that the AWP will drop enough in the short term to force a breach of 40 cents in May. Technical traders will not push the market through support on their own, but instead place sell stops below 40 cents.

If we are correct in our assumption that the market will hold support, we could see a rebound back to the mid 40s, which should run into a lot of overhead selling from the many origins that have yet to dispose of their crops. This would then set up another test of the 40 cents level, which will be harder to defend the second time around.

Outside markets will of course continue to play an important role in all this. Recently, commodity markets have followed the collapsing stock market lower and if we see further steep losses in global equity markets, all bets are off.

Those who believe that the stock market cannot possibly get much worse need to consider that former Fed Chairman Greenspan had his now famous 'irrational exuberance' speech in December 1996, when the Dow was trading at about the same level as it is now. Back then he talked about "unduly escalated asset values, which become subject to unexpected and prolonged contractions as they have in Japan over the past decade".

So what seems cheap today was deemed expensive back then, when the world was still in relatively good shape compared to now. Speaking of Japan, let's not forget that the Nikkei Index reached almost 39'000 points at the end of 1989, while today, some 20 years later, it is only trading at 7'200 points. The lesson to be learned here is that it's all relative when it comes to values, and that there is no telling how low the Dow Jones or commodity prices will go in this ongoing deleveraging process.

Plexus Cotton Limited

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