NY futures came under heavy pressure this week, with December losing 524 points to close at 57.18 cents.
Credit market jitters led to a broad based sell-off in the world's financial and commodity markets this week and the cotton market got pulled down with it. Since making an intra-day high of 68.80 cents exactly one month ago, the December contract has now given back nearly 1200 of the 1700 points it had gained during the previous move.
The same forces that boosted the market a couple of months ago, namely hedge and index funds, are now causing the market to retreat as some of these long positions are being sold in order to meet rising margin calls and redemptions.
What is currently happening in the credit markets is really stemming from a chain reaction that started with the implosion of the subprime mortgage market.
After years of low credit spreads and low volatility, which led to a perpetuation of this credit bubble via imaginative structured financial products, the subprime issue has now forced a re-pricing of risk, a tightening of credit standards and much higher volatility.
This in turn has caused a liquidity problem for hedge funds, banks and insurance companies alike as they were suddenly faced with escalating margin calls for some of their highly leveraged bets. Since the market for these credit products has dried up, hedge funds and banks resorted to selling other assets, such as commodities, to come up with the needed cash.
While the current liquidity squeeze may be short lived, the market is now worried that this changed credit environment will eventually affect the general economy and lead to a recession.
The re-pricing of over a trillion dollars worth of adjustable rate mortgages is expected to lead to increased foreclosures over the next 6 - 12 months, which may put pressure on housing prices and wipe out of a lot of home equity.
Think of it as a reverse wealth effect, which could scare consumers into sitting on their wallets. Since over 70% of the GDP in the United States is based on consumer spending, it is easy to understand why the market is so worried about a recession.
Had it not been for the turmoil in the financial markets, cotton would have had several reasons to trade higher this week. For one there are weather concerns, as the extreme heat in the Mid-South and Southeast continued to take a toll on the crop and what once looked like a record crop is now being reduced to an average one.
A little further to the west, the open South Texas crop received unwelcome heavy rain from tropical storm Erin this morning, which may have caused some yield and quality losses.
Another positive development was the pick-up in US export sales, as nearly 400'000 bales of Upland and Pima cotton found a home last week. With prices being even lower now, we should see continued good demand for US cotton.
