NY futures rebounded this week, with March gaining 188 points to close at 72.90 cents, while December rallied 371 points to close at 82.99 cents.
With the CRB index and nearly all commodities turning back up this week, cotton was able to bounce as well but it did so in rather listless fashion, with volume dropping to a trickle and open interest receding by another 12'000 contracts this week. This kind of action suggests that it was merely a 'dead cat bounce' off of long-term support and not yet the beginning of a new leg up.
One of the main features this week was the widening of the differences between the various months, with the May/Dec spread at one point trading as wide as 1068 points, which represents over 150 points of carry per month. Even today's settlement of 1009 points or 144 points per month is still more than enough carry.
So why is this happening? The main reason is money, or rather a lack thereof. With the certificated stock approaching 900'000 bales this morning, carrying this kind of an inventory will require about 350 million dollars. On top of that a merchant willing to take the certificated stock would have to sell 9'000 July or December futures against it in order to lock in the spread and these short futures would require 32 mio dollars in initial margin requirement plus whatever variation margin may get generated.
A short futures position of that size represents a huge potential liability and therefore, as tempting as this carry trade may seem, the trade may be impossible to pull off from a financial point of view.
There have been some rumors that possibly a hedge fund and a merchant might team up to combine financial strength and expertise in an effort to control the certificated stock. But even though there is a potential profit of 200-250 points in this spread game, hedge funds typically look for more than a 3-4% return when tying up that much capital for seven months.
Speaking of joint-ventures between hedge funds and commercials, it was reported today that Ospraie Management LLC, a $9 billion hedge fund, agreed to buy ConAgra Foods' commodity trading and merchandising operation for $2.1 billion.
The ConAgra unit has 144 facilities, which are mostly located in North America, and employs 950 people. The New York-based hedge fund two years ago started its Special Opportunities fund, which buys stakes in commodity producers such as agriculture and mining companies. We believe that this marks the beginning of a new trend in which cash rich outfits are looking to invest in the commodities arena by acquiring trading companies.
Despite all the news headlines regarding a credit crunch, there is no shortage of cash in the world. Even though some investment bankers, broker-dealers and hedge funds feel a severe liquidity squeeze or crisis after some of their highly leveraged deals have gone bad, there is plenty of cash around waiting for an opportunity.
