NY cotton future remain on defensive

14 Nov '08

6 min read

Not only have consumers reduced their spending in general, but they are now shopping for bargains in both goods and services. For example, instead of shopping at a luxury retailer they go to Wal-Mart; instead of getting a 70 dollar haircut, they get one for 30 dollars; instead of eating at an upscale Restaurant, they fire up the backyard grill at home. You get the picture! What we are saying is that the transaction volume of goods and services consumed is shrinking at a phenomenal rate and this will translate into a huge drop on these 70% of GDP.

As this 'value-added' component is being squeezed out of the economy, it will lead to a sharp contraction in corporate profits and hence business expenditures; and it will invariably lead to higher unemployment as well.

However, from a commodity perspective the drop may not be quite as drastic as these shrinking dollar volumes may suggest. For example, if someone buys a pair of jeans at Wal-Mart instead of a luxury retailer, the transaction volume (GDP) may drop 50%, but the transaction still involves the same amount of goods. In other words, we need to make a distinction between dollar volume and items sold.

Also, while this retrenchment of consumers is most pronounced in the US and parts of Europe, emerging markets are still doing comparatively well. For example, this week China reported retail sales for October up 22% year-on-year, with garment sales up 20%. Some may question the reliability of statistics in China given the struggle we are seeing in the textile industry, but even if these numbers are overstated, we are still witnessing net growth in China.

Another factor that will support commodity prices in the longer run (emphasis on 'longer run'!) is the fact that governments and central banks around the globe have been frantically trying to halt this implosion by injecting unprecedented amounts into the financial system and they are now resorting to buying real assets in the economy.

The deeper the crisis, the more governments will get involved to bail out just about every sector of the economy. This is highly inflationary down the road, and if nothing else will revive nominal prices of commodities, this will! It is just a matter of time!

In the short term we see no quick fix for cotton prices outside a pronounced drop in the US dollar and for this reason we believe that it will be difficult for the futures market to rally much from current levels. Only strong export demand and an accompanying rise in the AWP would provide the basis for a sustainable advance, but that seems unlikely at this juncture.

With December going into the Notice Period next week, the downside may be contained for now, but once the December is out of the way we could easily see March challenging the lows that were set this week.

Plexus Cotton Limited

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