There are four things you need to know about the cotton market, and of course China’s current position is first and foremost, says Don Shurley, University of Georgia professor emeritus of cotton economics.
“No. 1, China holds 60-some-odd percent of the total cotton stocks in the world,” said Shurley during the Southern Region Outlook Conference in Atlanta held in September. “No. 2, cotton acreage in the U.S. has trended down. We’re up this year, largely due to 80-cent cotton last spring. But acreage has been down due to competition from corn and soybeans.”
No. 3, he continues, is that the demand for cotton is down. “We went through a brief time period when we had $1 to $1.50 cotton, and the demand for cotton took a big hit. We’ve started to make some strides back up, but I don’t know if we’ll ever get where we used to be,” he says.
The last major thing, says Shurley, is that the new farm bill has PLC and ARC payments for all major row crops except for cotton.
“All of the other covered commodities that a farmer would consider as an alternative to plant other than cotton potentially have PLC and ARC payments. That has implications as to where cotton acreage can go in terms of competitiveness,” he says.
China now sits on roughly 61 percent of cotton inventories in the world, notes Shurley. For some political or otherwise unknown reason, it has all of this cotton but chooses not to use it, he adds.
“Sure, China has a lot of cotton, and if they buy it and don’t use it, yes, we have a world-record amount of cotton, but if it’s sitting in China and not being used, then effectively we don’t have nearly the stocks that we think we have. It’s not being made available in the pipeline, so the fact that we have a record amount of cotton in the world, at least in the short-run, doesn’t matter.”
There’s a lot of uncertainty about what China wants to do with its cotton, he says. “They’re our No. 1 customer of U.S. cotton. What they do with the cotton they have will have a great impact on whether they need to import anything from the U.S.”
Anatomy of a downward price trend
In charting the downward trend of cotton prices, one can go back to last March, April and May, when the price climbed above 80 cents, says Shurley.
“It even went up to 85 cents, and then, around the first part of May, we began a downtrend, and we’ve lost roughly 20 percent of price since that time. Unfortunately, I don’t think very much cotton was sold back when prices were higher, and I don’t know why not. By ‘sold,’ I mean either hedged or a forward fixed-price contract. So we’ve had a 20-percent loss in price and potentially in revenue.”
Looking ahead to the 2015 crop, the current futures price for cotton is in the low-60s as of this week. Just operating costs only are about 60 cents a pound based on an expected yield of two bales per acre.
“So people are starting to think that we won’t grow as much cotton next year. But who knows?" he said.
Back in March, when the USDA released its first planting intentions, cotton was in the 80s, and everyone knew that the planting intentions were on the low side, says Shurley. When the June report was released, the number was higher, and the actual planted acres ended up being more than what growers had indicated in March, he says.
“A lot of traders in the market didn’t like cotton when it was in the 80-cent range. They thought it was over-priced. When it pushed to 84 to 85 cents, people became even more nervous. When you’ve got a speculative side of the market that’s a little antsy to begin with, and then a fundamental, economic factor comes into play and provides you with a reason to jump ship, all the speculative interests in the market sell out, and there’s no support. That’s how we lose 20 percent. There’s nothing left on the speculative side to support the market.”
U.S. export numbers, says Shurley, have occasionally been disappointing this year, and India produced a cotton crop that was larger than originally thought. Added to this are the increased stocks in China and in the remainder of the world, he says.
“China has a massive buildup of stocks, and we have a buildup of stocks worldwide. But if we don’t consider the cotton that China isn’t doing anything with, and look at just what’s left in the rest of the world, everyone said those stocks actually were dwindling and were tight. That’s why the higher prices were being justified.”
The market, however, completely ignored the facts, says Shurley. Almost every month, when the report was released, these stocks would get larger, yet the market would continue to operate on the assumption that the market was tight. The facts were that stocks in the rest of the world were not as tight as we believed them to be.”
Looking for a price bottom
“When the August report was released, it did not reflect what we saw coming as declining crop conditions and yield potential. When September numbers were released, 1 million bales were trimmed from the U.S. crop, going from 17 ½ million bales to about 16 ½ million bales. As a result of the smaller production, USDA trimmed 700,000 bales from exports, reflecting the fact that we have a smaller supply available. It also reflected the increase in India’s crop.”
On the world side, ending stocks are at about 106 million bales, he says, a record-high amount by far.
“China is holding a lot of cotton, and that didn’t just happen overnight. This is a story that’s never told – the three things that have occurred that have allowed China to build these stocks. In 2009, we had a large drop in production due to acreage and weather, and we had a rebound in usage. So we had increased use and demand coupled with a decline in production. That allowed stocks to begin to tighten.
“We then went through a period of two consecutive years of increased production while demand began to trend down. This is what started to create the excess supply worldwide. This allowed stocks to accumulate worldwide. All China did was to come in and buy and import. This allowed China to accumulate stocks. The excess stocks were there because of weak demand and excess production. China bought cotton, had it shipped in, and then let it sit there. If not for those circumstances, China would not have been able to do what it has done. China didn’t create the stocks. A large portion of those stocks may be China’s own cotton but the oversupply was nevertheless created because China didn’t use its own cotton and continued to import instead.”
On the positive side, cotton production has begun to trend down, says Shurley, and usage has started to trend back up.
“We’ve had five years where production has outpaced demand. That will allow excess stocks to be accumulated. But the gap has started to narrow. If use continues to show some slow improvements, and if U.S. and worldwide production trends down again next year, we could perhaps continue to narrow this gap and get supply and demand back in closer balance.
The fly in the ointment is that China is still sitting on all of those stocks.”
China has historically held a lot of cotton, says Shurley. They have the No. 1 textile mill industry in the world, and holding a lot of cotton gives support to that industry. Also, if they hold all of this cotton, not only does it give a ready supply to its mills, but it also potentially gives them a way to control the market, he says.
“Going forward, U.S. cotton is going to have to adjust to the fact that we’re going to get back much closer to normal. This past year, our exports, both numerically and market-share-wise, really declined. The U.S. cotton grower is going to need to get used to a much more normal number in terms of exports to China. That’s what the low prices are reflecting right now.
“We went through three straight years – 2011, 2012 and 2013 – where we had very large acreage abandonment. This year, we’re looking at much more normal-level exports and demands for imports from China, and much less acreage abandonment.”
The Southeast and the Southwest, says Shurley, are the stabilizers in terms of U.S. cotton acreage.
“There are about 6 ½ million acres of cotton in Texas, and about 4 million of those won’t be planted in anything but cotton. There just isn’t anything else to plant. In the last three to four years, the acreage numbers have stabilized in the Southwest and in the Southeast compared to a continued downtrend in the West and the MidSouth.”
This year, he says, the MidSouth bumped its acres back up for the first time in several years. This was spurred by the high cotton prices last spring.
“The bottom line on the price outlook for 2015 is 65 to 75 cents. Acreage and production could be down both in the U.S. and worldwide. Demand should continue to slowly improve. Exports will depend on Chinese and other foreign crops.”
China has a sticky situation, notes Shurley. “If they start leaking some of that cotton into the pipeline too much, it weakens price. It’ll make their mills happy, but it won’t make their farmers happy. The alternative is to hold it off the market as they’ve been doing and allow prices to be higher than they otherwise would be. Then they’re sitting there with all of this cotton – some bought at $1.35 to $1.50 per pound – sitting there with no home, and some of it is going on three or four years old. So the quality of it is getting to be questionable.”
Shurley explained that details are starting to come out about a possible target price program in China where a subsidy would be paid for the difference between the target price and the market price. This policy may encourage their growers to increase cotton acreage, which could make China more self sufficient.
“We still don’t know how that would impact their reserves and their demand for imports.
It’s not likely that China will dump all of these stocks on the market. It’s more likely that China will act to stabilize the price of cotton, and that might improve the outlook in terms of their demand for imports.”