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Cotton market experiences some erratic up & down sessions

05
Jun '09
This seems to signal that the 'con game' may finally be up and that it will become increasingly difficult to secure the funding for the massive deficits that the US government, as well as the financial and private sector, has committed to. One of the main problems is that 70% of US GDP is based on consumption and in order to avoid massive contraction, this consumption level needs to be sustained. With private and business consumption dropping, the government has stepped in to fill the gap, but this does not solve the structural problems that exist.

In order to have the right to consume, one must produce. This is what the US economy used to do, but over the last two decades it somehow convinced itself that it would just let other nations produce, thereby creating large annual trade deficits, while it would 'settle' these deficits with IOU's (Treasury and Agency Securities). Sooner or later this had to lead to a credibility issue and that is where we stand today. Unfortunately there is no quick fix in sight because these structural imbalances need years to be corrected and this leaves a further pumping up of an already massive debt bubble as the only remedy right now. The alternative would be an immediate collapse.

The reason the US dollar has not shown more ill-effects from this policy so far is that other economies have engaged in similar strategies, which have been masking the problem. However, these competitive devaluations are starting to show side effects, with the main one being the threat of high or even hyper inflation down the road and this in turn is leading to an appreciation of commodity prices. Picture it this way - if the whole world engages in printing money, then sooner or later an ever increasing pool of money will chase a finite amount of resources and this has to result in higher prices.

We believe that the investment world has started to realize that holding cash in an inflationary environment doesn't make sense and we are therefore seeing a move back into equities - particularly foreign equities - as well as commodities. This will by no means be a linear move up, but over time we believe that all nominal prices of commodities will be substantially higher on the account of a depreciating dollar alone, irrespective of the individual supply/demand scenarios.

So where do we go from here? In the short-term the July liquidation will take center stage and in this regard it will be interesting to see how this growing certified stock will be dealt with. If the July/Dec spread keeps widening out and offers full carry, then it won't be as relevant where the outright price level is and we could see a taker even if the futures market was priced too high in comparison to cash prices.

While the initial rally to 60 cents was sponsored by spec short-covering, it is now the trade shorts that have begun to buy in their positions. The latest CFTC report showed the trade still 9.3 million bales net short, so there is a lot of potential buying power pent up in this position. We do indeed expect that the trade will be a net buyer of futures over the summer months as old crop basis-long positions are being sold to mills. Since speculators are not expected to sell commodities in a major way given the outlook for inflation and a weaker dollar, we need to ask ourselves where potential new shorts are going to come from.

Last week we thought that the market would give us another shot at prices in the low 50's, but after what happened in the outside markets this week we are not so sure about that anymore.

Plexus Cotton Limited


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