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US dollar to come under increasing pressure
20
Mar '09
NY futures couldn't make up their mind this week and closed basically unchanged, with May edging up just 4 points to close at 42.87 cents, while December added 15 points to close at 48.10 cents.

Even though the waters seem calm at the moment and the May contract has closed within a very narrow range of just 208 points over the last three weeks, there are several cross-currents we need to be aware of.

If we just look at the cotton market in isolation, it seems to make sense for the market to be stuck in a relatively tight range. On the one hand we have very supportive US export sales, with 2.7 million statistical bales of new commitments over the last two months, and mills are generally operating at decent margins at the current low prices. On the other hand we still have several origins that have yet to dispose of huge inventories, such as Central Asia, West Africa and India, which keeps the trade from getting too excited about a potential rally.

However, as many of us have learned in a painful lesson last year, the factors that drive commodity markets go far beyond the traditional supply and demand issues of a particular commodity. In the years leading up to the 2008 market crash, we saw commodity markets become a new playground for index and hedge funds. By piling hundreds of billions of dollars into commodity markets they tripled and quadrupled open interest and eventually forced prices to explode to the upside, often in the face of fundamental reasoning.

Then in late summer of 2008 the financial meltdown ensued, leading to massive deleveraging in just about every asset class, with the exception of government bonds. In this panic-like rush to liquidity, hedge and index fund long positions were cut dramatically. In the cotton market, outright spec longs in the futures market dropped from 13.4 mio bales a year ago to just 3.1 mio bales last week, while index funds cut their net long from 12.3 to 6.0 mio during the same time frame. Over the last few months this long liquidation has subsided and we are getting to the point where money from these sources is starting to flow back into the market.

Even before yesterday's surprising Fed announcement, it was reported by a fund tracking service that commodities saw net inflows of 7.1 billion dollars last month, second only to February 2008, when 10.0 billion dollars poured in. In the first two months of this year, the net increase already amounts to 12.1 billion dollars. Gold has received the lion's share of this money, followed by energy, while exchange traded products linked to agriculture have only seen a relatively moderate amount of 0.5 billion dollars so far. However, the important message here is that after the mass exodus we have seen late last year, the tide seems to be turning.

Yesterday's Fed announcement is certainly helping to build the case for commodities. True to the game plan that Mr. Bernanke outlined over six years ago, the Fed continues to create money out of thin air, this time by buying 1.15 trillion dollars worth of US treasuries, mortgage backed securities and agency debt.

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