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NY cotton futures reach their highest peak
Oct '10
NY futures had another explosion to the upside this week, with December gaining 597 points to close at 121.68 cents, while March rallied 859 points to close at 118.80 cents.

Cotton futures reached their highest peak since trading began on the New York Cotton Exchange in 1870, with the December contract posting an intra-day high of 130.50 cents and a closing high of 129.59 cents on Tuesday. Only during the Civil War (1861-1865), when a blockade imposed by the North prevented cotton from being shipped to Europe's textile mills, were cotton prices higher at 189 cents.

But the NY futures market wasn't alone with its record-breaking performance, as the A-index posted an all-time high of 147.00 cents on Wednesday and the Chinese spot futures contract closed at a mindboggling 204.67 cents. As we have stated before, it is the physical market, led by an out-of-control Chinese market, which has been the driving force behind this rally. In only a little over three months, since July 21, the A-index has now gained an incredible 64.30 cents, while December futures have barely been able to keep pace, rallying 'just' 48.67 cents.

We still believe that we need to look at the physical market for clues as to where the futures market might be headed - not vice versa. As of today, mills were still willing to pay 140-142 cents for prompt high grades landed the Far East, while prices for first quarter shipments were in the 132-136 cents range and Brazilian/Australian high grades for summer 2011 shipments are currently in the 124-130 cents range. From that it follows that NY futures should be no more then approximately 14 cents below these prices, otherwise they will present an arbitrage opportunity. When comparing futures and cash prices we need to bear in mind that certified cotton taken up against the December contract probably wouldn't ship until early February.

Therefore, if we look at 135 cents for Feb/March shipment, December futures make sense at 121-122 cents. Earlier this week, when the December contract briefly rose to 130 cents, it was clearly overvalued in terms of what mills were willing to pay for Feb/March shipment at that time and the sell-off since then was simply an effort to bring values back in line. On the other hand, if spec selling were to force spot futures too far below physical prices, similar to what happened after the key reversal two weeks ago, then the trade would happily step in as a buyer.

For futures prices to trend lower we first need to see the cash market soften, which hasn't happened yet. However, the widespread panic we have been witnessing recently has finally started to subside and the old saying that "the best cure for high prices is high prices" may still hold true. While finer count spinners are apparently still able to make ends meet, the open-end sector is hurting, because the raw material component represents a higher percentage of total cost. We have even heard of one instance where an open-end mill decided to halt further production for now and to sell its existing yarn inventory at a steep profit. The level of demand destruction is difficult to gauge, but we have probably reached a point at which an increasing number of mills are starting to resist these higher prices.

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