NY cotton futures remain on defensive this week

25 Oct '08

5 min read

While we expect a relatively narrow range for cotton prices in the near term, the longer term outlook depends on a lot of factors that are difficult to predict at this point. As we have pointed out in previous reports, commodity markets have been and still are under severe selling pressure stemming from hedge and index fund liquidation. Nobody knows how much more these entities have to sell, but we are probably not at the end of it yet.

In an effort to quantify this flood of selling, we came up with the following 'back of the napkin' calculation. Last year total global hedge fund assets amounted to about 2.6 trillion dollars. Recent reports talk about redemptions of up to 40%, which would amount to roughly a trillion dollars. Now let's remember that these assets have been leveraged at a ratio of over 30-to-1, which means that a trillion dollars controls bets in the tens of trillions.

Since the market in credit derivatives has virtually been frozen for months, fund managers had no other choice but to sell other, more liquid assets such as equities and commodities, both in the US and abroad, in an effort to come up with cash for redemptions and margin calls.

There is no telling where exactly we are in this ongoing liquidation process, but what we do know is that it is a finite event. When the selling finally stops, we will be left with a US dollar that is substantially overvalued due to all the repatriation of assets, while commodity prices and securities will be severely undervalued.

The market will sooner or later react to these circumstances with a pronounced countertrend move, during which a falling dollar is likely to boost nominal prices of commodities and equities, regardless of their fundamentals. We therefore need to keep a keen eye on Forex markets for early warning signs on when the tide may turn for commodities.

Plexus Cotton Limited

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