As the 2009 growing season winds down, weather concerns, a world production shortfall and a debt-ridden U.S. economy are primary factors that will likely impact the cotton market over the next few months, according to Peter Egli, a cotton market analyst with Plexus Cotton Ltd.
The world production shortfall is one of the biggest in recent history, noted Egli, speaking at the Ag Market Network's September teleconference. “Currently, foreign production (global production minus U.S. production) is at 91.6 million bales and consumption at 109.2 million bales, giving us a foreign production gap of 17.6 million bales. In 2005, the gap was a little bigger at 17.8 million bales.”
The big difference was that in 2005 and 2006, the United States produced crops of 23.9 million bales and 21.6 million bales, respectively, creating a seasonal surplus of 18 million bales in 2005 and 16.6 million bales in 2006 to help out with the shortfall. However, because of a much smaller crop this season, the U.S. surplus is only 9.9 million bales. Essentially, the rest of the world will be left with a gap of 8 million bales, even after the United States has exported 10 million bales.
“The rest of the world will need every bale of U.S. cotton that is available. India may take the early lead in the export trade, but there will be 32 million bales exported, according to USDA, and less than 20 percent of that will come from India.”
As usual, China is responsible for a large percentage of the production gap, 12.7 million bales of the 17.6 million bale shortfall. While USDA is estimating Chinese imports at 8 million bales, “USDA has probably become conservative in estimating China's import needs because in the past, it has been too optimistic. So this leaves the door open for a positive surprise for China's import needs.”
Egli puts a bottom in the market at 55 cents, noting, “To me the market has much more upside potential than downside risk, but it won't be taking out the 65 cent resistance level anytime soon.”
For that to happen, other factors have to come into play, such as weather and economic factors, both of which have been unpredictable this year, and at times, gloomy.
“Right now, crops look promising in the United States and around the globe,” Egli said. “However, we still have four or five critical weeks to go before the bulk of the U.S. crops can be considered safe, especially since a lot of fields were planted late this year.”
Egli and a number of analysts have expressed concern about a colder than normal arctic air mass gathering in Alaska and northern Canada. “The fear is that the jet stream could transfer this cold air mass south and cause an early frost or freeze. There is already a weather forecast for the end of September calling for frost in the northern half of the Midwest.”
Quality of cotton can also be affected by cold and rainy weather, and this could trigger a market rally as well, according to Egli. “Over the last five seasons, we have been a bit spoiled by high quality cotton, but sooner or later, we will probably run out of luck in that department.”
Egli is iffy about the economy as well, despite the recent upturn in the stock markets, which are “mainly the result of all the money printing you're seeing around the globe, particularly in the United States.
“When we look past the U.S. government propaganda, we're still faced with a sobering reality that one of every 10 mortgages is in trouble, one of every 25 homes is in foreclosure and unemployment is still rising, albeit at a smaller rate. At the current pace, we're still losing about 2.5 million jobs a year, which is hardly encouraging.
“Government debt, including state, local and liabilities for government stock amounts to about 160 percent of the gross domestic product. If you include household debt, you're at 260 percent; if you add corporate debt, you're at 550 percent; and if you include Social Security and Medicare liability, you're at over 800 percent of GDP.”
Egli is firmly in the inflationist camp, noting, “It may take a while for inflation to gain traction after all the leveraging we have seen, some of which is still taking place. The value of the U.S. dollar will continue to weaken in relation to assets, perhaps substantially, and everything denominated in U.S. dollars will rise as a result.”
Based on that, Egli is much more concerned about cotton prices “running away to the upside at some point in the future, rather than collapsing. To time this event is extremely difficult, but I would not be surprised if we saw the beginning of it sometime next year.”
Egli does not put all the blame for commodity price volatility over the last few years on speculators. “Commodity futures markets are simply too small to suit the role of the new investment vehicle, especially with so much liquidity sloshing around the globe. Regulators have a really tough task because on one hand, you have to reign in this potential investment frenzy, while on the other hand, they have to be careful to not discourage additional speculators with overregulation.”
Egli says the trade is definitely in control of the cotton market at the current time and is one reason for a recent run-up in prices. “The trade works mainly from a basis long position, which means it's physical cotton long and short futures. So as existing inventories are being sold, these short futures get bought back. And since new crop is not available in large quantities to replace these basis longs being sold, the trade is a net buyer of futures, and that's why the futures market has been rising.
“This should change once new crop is harvested, and merchants put on increasing numbers of shorts again as new crop bales are purchased. However, there is a certain danger in the fact that the trade - in its relatively large short position - is running the show. If the trade wanted to cover, either because of a weather event or the falling dollar, who will be there to take over the shorts? The index funds won't do it because they are dictated by money flows only and traditional speculators - with their small positions at the moment - will probably jump on the bullish bandwagon.”
Egli sees a trading range of between 55 cents and 65 cents, “but there is the possibility for the market to go higher, perhaps into the low 70s. Depending on what happens with the economy or weather, there is an outside chance that it could go even higher than that.”