PLEXUS Market Comments
MARKET COMMENTS 27 Oct, 2022
NY futures remained under pressure this week, as December dropped another 229 points to close at 75.11 cents.
December is still in search of a bottom, as it has now dropped 42.57 cents in just two months. Hard to believe that December was still at 117.68 cents as recently as August 28!
Interestingly, futures open interest has increased considerably in recent months, rising from 172.5k contracts on July 7 to 247.4k contracts this morning, an increase of over 43%. Typically we would expect a drop in open interest during a market decline, as positions are being liquidated. While spec longs were indeed in liquidation mode, trade longs have stepped in and taken over these longs, and we saw a similar ‘swap’ on the short side.
When we look at open interest including ‘delta-ed’ options, we see a similar increase during this time frame, as total open interest increased from 235.8k contracts to 347.5k contracts (as of last week’s CFTC report). Apart from specs and the trade swapping positions, we also saw a big increase in spread positions since July.
The latest CFTC spec/hedge report for the week of October 12-18, during which December moved from a high of 87.17 to a low of 81.78 cents, showed that speculators are now 0.37 million bales net short, while the trade reduced its net short (both by buying new longs and covering shorts) to 6.12 million bales. Index funds now own the sole net long at 6.49 million bales.
US export sales reflect the dismal state of demand in many markets, as net new sales amounted to just 74,800 running bales of Upland and Pima cotton for both marketing years. Pakistan accounted for 59,800 of the total, with other markets booking only small quantities or cancelling cotton. There were seven markets with cancellations, led by China, which had a net reduction of 52,100 RB last week.
Shipments of 179,300 RB went to 20 destinations, with China receiving 85,300 RB. At least China is still taking in a decent amount of its commitments!
Total commitments for the current marketing year are at 8.75 million statistical bales, whereof 2.65 million have so far been exported. This compares to 8.85 million bales in sales and 2.05 million shipped a year ago.
The outlook for an improvement in demand is not rosy, as economic news is getting worse. The Global PMI (Purchasing Managers Index) is now in contraction territory, with the Composite Output PMI in the US (47.3), China (48.5) and the Eurozone (47.1) all showing lower economic activity.
Stocks, bonds and cryptos remain under pressure, with some of the bellwether stocks like Amazon (-48%), Google (-36%) or Facebook (-71%) all down significantly year-to-date. And now we are also starting to see double-digit declines in some of the hot housing markets. The car market is another problem, after some consumers bought overvalued used cars last year that are now being repossessed.
With central banks still playing the hawkish card, this negative feedback loop we are seeing in nearly all assets will only get worse and it is still anyone’s guess as to when ‘enough is enough’ and we’ll see a return to a more accommodative environment. Policy makers have become both arsonist and firefighter, creating ever increasing boom-and-bust cycles with their misguided moves.
Sooner or later central banks and/or governments will have to come to the rescue again, otherwise everything continues to implode and we are going to end up with a deflationary depression. Instead we will probably face prolonged stagflation.
Due to the massive debt load, most economies can’t raise interest rates much higher. Take the example of the US, where we have 31.0 trillion dollars in government debt (135% of GDP), while tax receipts (individual and corporate) amounted to 3.0 trillion dollars in the fiscal year that just ended. Therefore, if interest rates on the US debt were to increase to an average of 4.5%, then interest on the government debt would climb to 1.4 trillion dollars and eat up nearly half of all annual tax receipts.
This situation is similar for most economies, although Europe’s ratio of 95% to GDP is still slightly better, while Japan is hopelessly lost with its 260% debt-to-GDP.
So where do we go from here?
The lack of demand remains the overriding factor in the cotton market and there is still no improvement in sight. The USDA still needs to adjust its global mill use estimate to reality, which means cutting it by possibly as many as 8-10 million bales from the current 115.6 million bales. We don’t claim to know at what level demand is, we just go by what mills are telling us, and it’s depressing!
Although we are now technically in a bear market, we could still see some rallies here and there. The July to December period is the longest between delivery months (not counting October, which has virtually no open interest), and this allows for speculation to go unchecked. However, the upcoming Dec notice period will once again force cash and futures prices to converge.
Since early arrivals should encounter decent demand, as shippers need cotton to put against fourth quarter shipments, we don’t expect to see much pressure on December as we head into its notice period. At current levels we are more likely to see takers than deliverers, which could leave spec shorts exposed.
In other words, we expect December to hold up relatively well, while back months might come under more pressure once the crop has moved in and unsold supply builds. For the market to reverse out of this bear market, we need a switch to more accommodative monetary conditions, a weaker dollar, rebounding economies and reduced geopolitical risk. That’s a lot to hope for!