Thompson on Cotton: Volatility Reigns as Macroeconomics Take Over from Fundamentals

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    Where and when will new crop prices top out? For over two years, fixated on short supplies and endless demand, traders have driven December futures to continuous new highs. The most recent was last Monday when it hit 133.79. However, it was revealed last week the demand side of this equation may be weakening.

    This could very well be a warning shot across the bow that the top is nearby. Growing fear of a deep recession sent financial and commodity markets reeling. In turn, volatility increased with December futures trading from a high of 133.79 to a low of 124.29, a range of nine and a half cents.

    It closed the week near the bottom of this spread at 125.18 for a loss of almost three cents and only its fifth losing week since topping a dollar in late January.

    As for supply, the U.S. crop is getting shorter by the day. In the Southwest, triple digit temperatures and lack of rain are compounding the already dust bowl like conditions. With each passing day, we are nearing the point of no return as chances for a planting rain diminish.

    Coming off last year’s 17.5 million bale crop, the 2022 U.S. crop is currently estimated to be 16.5 million bales. Nevertheless, this number will change drastically depending on how much dryland cotton in West Texas and Oklahoma is abandoned.

    For example, when applying abandonment numbers from the most recent dry year, 2020, this crop would shrink to 14.8 million bales. Worse yet, using abandonment percentages from 2011, the driest year in two decades, a crop of only 12.8 million could be expected.

    Such a potential shortfall accompanied by strong demand has been the fodder feeding the bull. Though, as earlier mentioned, the latter is beginning to show signs of weakness. We have been suggesting it’s only a matter of time before consumer demand falls prey to inflation and declining economic conditions.

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    Up to this point, unfazed consumers have been spending faster than inflation blowing through stimulus money and running up credit card balances to pre-pandemic levels. Reflective of this, retail sales jumped four percent in the first four months of 2022 while inflation rose just 2.3 percent. However, there are indications this carefree spending behavior may be about to change.

    Two of our country’s largest retailers, Walmart and Target, delivered very disappointing first quarter earnings reports. Company spokespersons credit this partially to increases in supply chain costs but more so to reduced consumer spending. As a result, the Dow fell 1200 points or three percent on the day.

    Target stock dropped an astounding 20 percent, its worst one-day loss since 1987’s Black Thursday. There is growing fear a deep recession is inevitable as the Fed is adamant about lowering inflation at all costs. Worse yet, these trying economic conditions are not confined to just the U.S. as consumers worldwide are contending with inflationary pressures.

    History has shown we have never been able to stave off a recession following a period of high inflation. No matter how warranted, efforts to slow economic growth will force cotton consumption lower putting the estimated world use of 122 million bales in great jeopardy.

    Where to from here? With macroeconomic factors influencing the current market more so than fundamentals, volatility will reign supreme. As December futures slowly separates itself from July, the tug from the five million bales of on call sales will be less. Traders will be watching for further signs of weakening demand and changes in consumer spending patterns.

    Markets do not like uncertainty, and this is the case considering such economic upheaval. Hence likely the reason specs reduced their net long position last week by 3,000 contracts to 6.7 million bales. Considering all that is in play, its a good bet we have seen the high for the December futures contract. If not, we are darn close.

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