NY cotton futures displays mixed performance

02 Jun '12

6 min read

We don't want to downplay the problems in Europe, as many economies there are in deep trouble, but so are the US, Japan and to some degree even China. While we agree with the analysis of the current scenario, we feel that traders are reaching the wrong conclusion in regards to the fallout from this deepening crisis.

Although deflationary forces are clearly at work, central bankers around the globe have basically unlimited powers to prevent a collapse in nominal prices. While the Fed and its counterparts may have taken a backseat in recent months to assess whether the global economy would be able to gain some traction on its own, they will be quick to step in again if the need arises.

This week we have already heard from several Fed governors that new stimulus may be just around the corner. We believe that it is just a matter of 'when' and not 'if', and once central banks intervene, the switch will immediately go to “risk on” again.

When we look at the price of cotton in terms of gold instead of depreciating paper currencies, it is already near historic lows of 16 milligrams of gold per pound of cotton, just slightly above the record low of 14 milligrams/pound in early 2009. In other words, cotton is cheap, although that doesn't necessarily mean that it won't get even cheaper in the months ahead.

Cotton's fate over the coming months will to a certain degree depend on what happens in China. The China Cotton Index (CC index) amounted to 134 cents/lb today, nearly double of what the spot month in NY futures is currently worth.

This dual market scenario is leading to interesting dynamics, especially if the Reserve keeps sitting on its large stockpile of an estimated 18 million bales. All indications are that this is going to be the case at current prices, because the Reserve typically doesn't sell its stocks at a loss.

This would mean that China would have to import more cotton and/or yarn to make ends meet. Quotas seem to be in short supply at the moment and are trading as high as 3000 yuan/ton in the secondary market.

Could it be that by restricting the issuance of further quotas the government is trying to force the local price to a level at which the release of Reserve stocks becomes profitable?

Instead of paying prohibitively high local prices, Chinese mills may increasingly turn to importing yarn. This will allow them to indirectly gain access to cotton at international prices.

In the first 4 months of 2012 (January to April), yarn imports amounted to 351'868 tons, or 64 percent more than a year earlier, while yarn exports declined by 16 percent to just 112'479 tons. We believe that this trend of importing cheap yarn will become more pronounced in the months ahead.

International supply/demand statistics are probably not properly reflecting this new trend, as they have been scaling down Chinese mill use, but may have neglected to account for thehigher yarn output in other markets, such as Pakistan, India and Vietnam.

So where do we go from here? The market has discounted a lot of negative news during its fall from 90 to 70 cents. Although the trend is clearly bearish and we may see even lower prices ahead based on the dismal statistical picture, we shouldn't neglect the potential for countertrend rallies.

However, any decent bounce will probably invite additional grower selling, while dips below 70 cents will be an incentive for mills to become more active. We therefore feel that the market is likely to spend most of its time in a new range between 65 and 78 cents in the foreseeable future.

Plexus Cotton Limited

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