When markets get tight, they usually ration demand by simply kicking the price into a zone where a good margin of end users cannot make profits. A higher futures price, or a higher basis, or both can occur to knock the wind out of the consumers. But a market can also ration by spread inverts, or as the young and the restless call it – contango. A steep invert can push buyers into a holding pattern, as they run inventories down in order to wait for the cheaper raw material. Cotton has gotten itself into the ‘no-contango’ mode in recent months, as forward months have made impressive gains over back months since the late May/early June lows.
One spread has been spectacular, that being the Dec 13/Dec 14. Back in Nov, this spread traded -350, and today stands at +1100. In 9 months the spread has moved up 1450 points. This can be compared to the Dec 13 futures, which has moved from 7450 to 9050 in those 9 months. This is very unusual in that the spread has gained nearly as much as the leading spot contract which is higher by 1600 points. The spread gain is 90% of the spot futures gain since Nov, meaning this market is putting a majority of the rationing purpose into spreads rather than just a higher price.
One other almost unnoticed event working through this market is that the rough parity with the grains has been reached. Cotton matches up with corn, and remains slightly below soy. But the large per-acre disparities in profit margins are gone. The Southern hemisphere will grow more cotton this year, maybe a lot more.
Varner View
With the huge inverts facing the market now, merchants will be stopped cold of buying cotton, hedging it on the board, then selling as best they can. Most sales from here on will likely be based Mar or later, and back-to-back. Merchants are thus forced into a pigeon hole and cannot operate in a free-wheeling system. This will put a huge damper on sales, and with a 2.8 Mb carryout, that’s just what the market wants. Sales stand at 3.4 Mrb, and with such a price-wall, new sales will be miniscule compared to the go-go days prior to May. If we assume a rollover this year of ¾ Mb, then total sales may not reach 8 Mb by year’s end……………As for trading, we sold a few Decs today at 9200 +/- , and will probably treat as a short term play. Farmers should gear up for more hedging. One more thing – Dec 14 traded + 8000 today. That’s a walking dead contract.
Technicals
Spot chart reached our objective at 9180, but this is a soft target that may not matter much. Chart today shows the Dec 13 plotted against several spreads. All spreads are front month first. Spreads have tracked nicely with market direction, and like the Dec 13, all have posted new highs. Carry is 85 ticks/month, so one can calculate carry for the spreads to see how much the invert is. The Dec 13/Dec 14 is thus about 1600 points above carry, while the Mar 14/July 14 is about 650 points above carry.
