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COTTON SPIN: Looking Ahead to Next Year

The small size of the US crop will likely give us an ending stocks outcome similar to or even smaller than those in 2014
<p>The small size of the U.S. crop will likely give us an ending stocks outcome similar to, or even smaller than those in 2014.</p>
Planting time uncertainty will be heightened as the market tries to size up how much Chinese growers may be cutting back on cotton planting.

The holiday shopping season is in full swing. That should serve as a reminder that it is never too early to be thinking, or even shopping, for protection of next year’s cotton crop. 

The marketing plan for next year is obviously shaped by the price outlook. My outlook for 2015 cotton prices is, frankly, not that positive. The NY futures market gives us one prediction. The Dec. ’15 cotton futures contract has been trading between 63 and 65 cents this fall. That suggests a commercial market expectation similar to slightly better (i.e., tighter) supply and demand conditions next year, compared to this year.

However, when I try to follow this up with supply and demand projections, I come up with an increase in ending stocks for the 2015 crop, relative to the current crop. Consider the following:  Due to lower prices, U.S. growers will likely plant fewer cotton acres in 2015. The cut may be more pronounced where soybeans or peanuts are a viable alternative. Since Texas has fewer alternatives, and the prices of those grain alternatives have also weakened, there may be only a small reduction in cotton plantings.

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For the sake of argument, I assume that U.S. cotton plantings will be less than 10 million acres. Since soil moisture conditions are better than in previous winters, and we may yet have additional El Niño rains, it is reasonable to assume that abandonment will be lower and yields will be higher than recent averages. It is not difficult to project a minimum of 15 million bales of U.S. cotton in 2015. Adding in the likely carry-in from the 2014 crop gives a total supply of around 20 million bales.

Given current trends in Chinese policy and tepid economic growth, I hesitate to pencil in increases in U.S. mill use or exports. So assume 14 million bales of offtake. The result would be around 6 million bales of U.S. ending stocks, which is about a million bale increase over the current marketing year. That is a recipe for even weaker prices than we are seeing now. I would tentatively project Dec. ’15 futures to trade between the mid-50 and mid-to-upper 60-cent range.  In other words, cash cotton prices may only be at loan value, or a few cents above.

The opportunities for seeing prices at the higher end of my forecasted range often occur early in the year. Historically, we have seen price spikes around the new year and also in association with planting reports (early February, late March, and late June). The planting time uncertainty will be heightened as the market tries to size up how much Chinese growers may be cutting back on cotton planting. 

None of that is certain. Texas growers market most of their cotton through marketing pools. I have no problem with that as long as folks are intentional about what they are doing. I also recognize that forward cash contracting has production, quality, counter-party, and other risks associated with it. Hedging has basis risk and perhaps margin risk, depending on the strategy.  Still, if Dec. ’15 is trading in the upper 60-cent range during the spring, I would encourage cotton growers to consider all of these approaches, and perhaps a mix of them. 

From a hedging standpoint, near-the-money put options on Dec. ’15 are trading relatively cheaply considering the time value. If I were going to be planting cotton, I would be shopping early for puts as a hedge against a lower crop insurance prospective price (to be established in late winter). If Dec. ’15 futures spike up into the upper 60s, I would also be shopping for a Dec. ’15 put spread of 65+ (buy):58 (sell) to protect the range of possible cash prices down to the loan rate. Think of the latter as another form of shallow loss protection.


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