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NY cotton future remain on defensive

14
Nov '08
NY futures remained on the defensive this week, with December losing 168 points to close at 41.30 cents, while March fell a more pronounced 483 points to close at 41.86 cents.

The negative feedback loop between the AWP (Adjusted World Price) and NY futures continued, as the weekly AWP dropped another 265 points to 36.12 cents, with the latest daily value reading 34.56 cents.

However, as the December contract heads into First Notice Day on November 21st, it faces a reality check in regards to its cash value, and by that measure it got clearly too cheap this week when it dropped as low as 36.70 cents during Wednesday's session.

As we have pointed out before, the replacement cost for Certificated Stock is roughly the sum of the AWP (price at which cotton can be redeemed from the loan) plus delivery charges, which typically run at about 550 to 600 points. This calculation does not even factor in the cost for 'equities' (= the price paid to obtain the right to loan cotton).

Therefore, at the current AWP of 36.12 cents the December contract would have to trade at a minimum of around 41.50 to 42.00 cents to make sense for delivery.

Before session, open interest in December still amounted to over 36'000 contracts,which compares to a current Certificated Stock of just 9'769 contracts (976'913 bales). In other words, if some of these longs were to insist on delivery, it could put the shorts in an awkward position.

Since they are not willing or able to face this potential showdown with takers, December shorts have no other choice but to buy or roll out of this predicament and hence we have seen the spread between December and March narrow to almost even during today's session before closing the day at around 100 points March over.

However, while December was able to rebound by a little over 200 points over the last couple of sessions, March and the rest of the board were unable to hang on to their intra-day gains, as they ran into a lot of selling at higher levels. With business on the export front slowing to a trickle, merchants and coops are asking themselves where the buyers are going to come from, as most of the traditional markets are in bad shape at the moment and there is no hope for an immediate turn of affairs.

Last week we argued that the US is headed for a Depression and since we seem to have caused a bit of a stir with that comment, we would like to elaborate in greater detail on it. The textbook definition of a Recession is two consecutive quarters of negative growth in Real GDP, which has not yet occurred but is practically a given at this point.

There is no clear-cut definition of what constitutes a Depression, but typically it is understood as a prolonged and deep economic downturn beyond the regular business cycle, with GDP dropping by more than 10 percent per annum and the unemployment rate shooting up much higher than in an average recession.

To suggest such a steep drop in US GDP may seem preposterous, but when we use a commonsense approach our conclusion may not be as far fetched as it sounds. The US economy is made up by over 70% of consumer spending. Since the financial collapse which occurred about two months ago, we have witnessed a drastic change in consumer behavior.


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