U.S. cotton producers may have been victims of a run of bad luck, including having too much strict low middling, 1-1/16-inch cotton, when New York futures peaked above 80 cents per pound in October and then began a descent that has continued for eight months.
That phenomenon of having too much cotton the rest of the world did not want wasn't the only factor, but it did play a role in the subsequent drop of the nearby New York contract from that 82-cent level to 45 cents per pound, according to Ed Jernigan, chairman and CEO of Globecot Inc.
“I feel very humble trying to talk about the market,” said Jernigan, presenting the global supply/demand outlook for 2004 and 2005 at the Global Cotton Quality Summit in Singapore. “I did not think the market would break as much as it has the last 30 days or the last six months.”
The Summit, organized by Globecot and Bayer CropScience, brought together textile mill representatives and others from 17 countries, most of them in Southeast Asia to discuss the world textile outlook and Bayer CropScience's Certified FiberMax program.
What has been so mystifying about the cotton price direction to many analysts is that the plunge came at a time when market fundamentals were pointing to higher, not lower, prices.
World ending stocks, for example, have been hovering around 32 million bales, indicating the tightest stocks levels since the 1994-95 cotton marketing year (August-July) when prices last rose above $1 per pound.
“Looking at USDA's ending stocks numbers, you can see that… it didn't change,” Jernigan noted. “Last September when the market was headed for over 80 cents, USDA was projecting world ending stocks to be about 32 million bales and never really vacillated from that.
“Here we are at the end of the season, and USDA's still projecting the same thing.”
Other factors, including China's production and consumption numbers and the decline in U.S. ending stocks to the lowest levels since 1995-96, have also been on target.
“One major difference, though, and we'll come back to this later, is that in 1995-96, the United States consumed nearly 10.2 million bales; this year, the United States will consume only 6.3 million,” he noted.
One interesting factor, he said, is although the prices of different growths around the world have declined from as little as 9 cents to as high as 22 cents per pound, New York nearby cotton futures have declined 27 cents per pound.
“One thing we can say, having been in the futures business the last 25 years, is that New York futures this year have exerted a much greater influence than ever before on physical prices worldwide,” he noted. “And I think the trading rules at the New York Board of Trade have had a great deal to do with that.”
Jernigan, whose firm handles 10 to 15 percent of the trade volume in cotton futures and options on the New York Board of Trade and serves as consultant to a number of international companies, has been one of the leading voices calling for a change in the base grade and staple for cotton that can be delivered against New York futures.
Established in farm bill
“No one can really point to a specific date when strict low middling, 1-1/16 became the base grade and staple for the New York contract,” he noted. “It apparently was started in the 1960s and became established in the farm bill in the 1970s.”
At the time, strict low middling, 1-1/16 inch was the grade and staple most used by U.S. textile mills, which accounted for 70 percent of sales by U.S. growers. U.S. textile mills dominated the cotton market until 2001-02, when domestic mill use dropped below exports for the first time.
Another development that normally would have been bullish for U.S. futures prices was China's need to import large amounts of cotton after weather problems reduced its 2003 crop to the equivalent of 22 million bales.
When Jernigan, speaking at last January's Beltwide Cotton Conference, forecast that China would need to buy more than 8 million bales to meet the demands of its textile mills in 2003-04, his prediction was met with some skepticism. But China is now believed to have bought a record 8.8 million bales.
“Traditionally, China buys some strict low middling, 1-1/16 to supplement its domestic supply of lower grades,” said Jernigan. “But this year's crop was the lowest in quality in 30 years, according to our friends in China. So they focused on buying middling, 1-1/8-inch cotton.”
The realization that a shortage of the higher grades Chinese mills normally use was looming touched off a buying frenzy that sent cotton prices above 80 cents in October. But once China's mills met their immediate needs, prices began to retreat.
“This development denied New York futures the market it needed and left much of the U.S. cotton crop with nowhere to go,” said Jernigan.
A third development that caused the market to sputter and eventually collapse after the market jump in October was that much of the world's cotton crop moved to merchants at the same time, leading to excessive merchant inventories.
Selling 2005 crop
“The high prices prompted many U.S. farmers to sell their crop,” said Jernigan. “Brazil's record 2004 crop (which wasn't harvested until this spring) was sold ahead along with some of its 2005 crop.
“Another factor was that a sizable portion of the physical cotton delivered wasn't even hedged. Instead of trade support for this market, you had trade selling of futures as merchants covered their positions.”
A fourth factor: The market has been denied buying between May and July by Chinese spinners. “In recent months, every time a mill has purchased cotton the price went down,” said Jernigan. “So why should they buy aggressively.”
Chinese mills have also become more adept at managing inventories, he noted.
“Chinese mills used to keep a two- to three-month supply of cotton on hand, but a recent survey indicated that 36 percent of the mills had less than a 30-day supply of cotton on hand. This shift in inventory means China needs 2.7 million to 5 million bales less to manage inventories.”
So where do prices go from here?
Despite the plethora of bearish factors that have been pummeling the market, prices have been driven even lower than they might have been because of emotion, Jernigan believes.
“Spinners now have very low inventory levels,” he said. “And we think world 2004-05 consumption could reach 100 million to 101 million bales. We're predicting China at 34 million bales; India's strong consumption is expected to continue and Pakistan's is expected to do the same.”
On the other hand, the Northern Hemisphere crops appear to be progressing well with California's San Joaquin Valley making one of its best starts ever. U.S. growers should easily produce USDA's forecast of 17.9 million bales or higher, Jernigan noted.
With U.S. beginning stocks of 3.6 million bales, normally considered a bullish number, and production of 17.9 million bales, U.S. supplies should reach 21.5 million bales. Subtracting domestic use of 5.6 million bales leaves the United States with 15.9 million bales available for export or about one-half of projected world trade for 2004-05.
If USDA's projection of 13 million bales of exports is on target, ending stocks will again be low or what would have been considered tight in previous marketing years, Jernigan says.
What is tight?
“But I'm beginning to wonder what is tight anymore?” he said. “When stocks fell to 2.6 million bales in 1995-96, ending stocks were 24.5 percent of domestic usage. In 1990-91, when ending stocks fell to 2.34 million bales, they were 27 percent. In 2003-04 with our lower domestic mill use, the stocks-to-domestic-use ratio was 57.1 percent.”
Jernigan expects Chinese production, meanwhile, to rebound to 29 million bales, “and it could go to 30 million, given the reports we're hearing.” Production in India could be up to 13 million bales with the crops in Pakistan, Brazil and Australia also up from 2003-04. He's forecasting a world crop of 102.1 million bales.
“World production of 102 million to 103 million bales will make it difficult for U.S. exports to achieve the levels of the last two years,” he notes. “But with world consumption at 100 million bales, there's not much room for error this year.”
Based on continued good weather, Jernigan is predicting that December futures of 45 to 50 cents per pound will be the low end of the trading range for the next few months with 70 cents at the upper end of the range if problems develop and China's mill use reaches even higher levels.
Given the tight world stocks-to-use ratio, however, he told the mill representatives in the audience that “whenever mill inventories drop, do some buying because, again, there is not much room for error.”