January 28, 2014
Expect no rally. Don’t wait for the bulls. Anticipate no help from the demand side to pull cotton prices up.
In fact, says Texas AgriLife Extension cotton marketing specialist John Robinson, based on world ending stock estimates, cotton prices should be lower than they are.
At best, Robinson expects prices to continue a sideways pattern—within the 70 cents to 80 cents range but with volatility and “considerable downside risk, especially if certain situations occur.” Those situations would include China dumping a significant number of bales from their massive reserves—which no one expects.
Robinson delivered this less than optimistic market outlook at the inaugural Red River Crops Conference, a joint venture of Oklahoma and Texas Research and Extension programs held Jan. 27 and 28 in Altus, Okla. The venue will alternate between Oklahoma and Texas in coming years.
Robinson said outside forces continue to influence cotton prices but the largest ending stocks level “ever” weighs heavily on the market.
The price boom and the surge in world cotton consumption that sent markets soaring back in 2010 changed the landscape. China began stockpiling cotton and helped the U.S. cotton industry as export markets increased. “We moved from a domestic market to an export market,” Robinson said.
A pattern of price spikes, increased acreage, price drops and reduced acreage often defines markets. “The price spike of 2010 resulted in excess production in 2011 and built up a surplus. But the market remained stable.”
That surplus has reached “historical levels. The price should be lower,” Robinson said. The reason it is not lower is because China bought a lot of cotton at a high price—from $1.40 up to $1.50 a pound. They have much of that in reserve; estimates run as high as 42.6 million bales while the rest of the world has “tight supplies.” China’s huge reserve has kept cotton prices artificially high, Robinson said. If they unload those stocks, they lose a lot of money; so they wait.
He said those high prices also produced “ripple effects,” in markets. “Cotton became less competitive with synthetic fibers. Normally, mills replace cotton with polyester and cotton prices fall. “But cotton has held up, even though we have lost market share. That can only be fixed when cotton becomes more competitive.” And that’s not likely to happen as long as China holds the reserves. The situation “has long term implications for building cotton demand,” Robinson said.
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He also said a flat yarn price is not helping cotton prices. “I don’t see a downstream market pulling cotton up.”
The general economy also plays a role as consumers tend to buy more clothing in a strong economy. Robinson says the country is no longer in a recession but issues still linger. Unemployment remains too high and the gross domestic product, at 2 percent, does not indicate strong growth. “We see no booming economy and don’t expect one within the next 12 months. So, we don’t see support for cotton demand. We see nothing for cotton that’s bullish.”
Except. “Export sales have increased the last few weeks following a slow December. Maybe there is more demand that we thought. We’re getting mixed signals. Still, overall, I don’t see a demand-side pull for cotton.”
Other external forces also affect cotton prices. Hedge funds and speculators move cotton prices with no real signals from supply and demand. Funds also create price volatility in the futures market as they get in and out over a two or three day period or within a week or two. “We saw a lot of fluctuation with hedge fund sell offs in 2013.”
Robinson says two types of funds play in the cotton market and have different influences. One segment buys and holds, often controlling a significant number of bales and influencing demand for cotton futures.
And trend buyers get in and out with nearby futures. “They watch trends and buy into the market and may be out again in two or three days. The market goes up and down as they get in and out.”
He said after Christmas these funds got back in the cotton market and created a rally. “The funds’ influence comes and goes and sometimes actions are based on factors that have nothing to do with cotton.”
The real joker in the deck remains China and what it decides to do with the reserve. An unexpected move could send the market down significantly.
Robinson says USDA has speculated that China had two goals to build the government reserve. The first is they did not want to run out of cotton and leave their huge textile industry short. The second factor was to “keep peace with growers.” They bought cotton to set a floor and support their growers. Consequently, they have artificially supported the world price for several years.
Since they bought the high priced cotton, they have bought and sold several times—for a small loss—and released it to their internal markets.
Even with those sales, “they still have a large surplus, 42.6 million bales with 15 million free to market.”
They could dump that reserve but Robinson doesn’t think they will. “They are changing their policy and moving away from high loan rates to a target price and paying a subsidy to growers and will stop adding to the stockpile.
“But what will they do with that reserve? If they dump it, they lose too much money and they lose face.” If they don’t sell it they lose money with storage costs and also reduced quality. No one knows what they will do, but they may be replacing old cotton with new to maintain quality, Robinson said.
China will take a loss on these bales, regardless of what they do. They lose if they auction it off and they lose if they continue to hold it.
Robinson said he could envision a conspiracy theory in which a Chinese bureaucrat starts thinking about all that cotton and decides to sell two to four million bales. “That would be a surprise. The world price would come down and the futures market would come down.”
He said the downside risk would be “at least 10 cents a pound.”
He doesn’t anticipate that happening. “Inertia rules the day. Doing nothing is the easiest thing to do.” China may be hoping that a short crop somewhere will open up a market and they can replace the entire shortage with their stockpile. A drought in India could be such a catalyst.
Even with a catastrophic crop year somewhere, China’s stockpile filling the gap would put a cap on upside price movement.
All those factors together support Robinson’s contention that cotton prices will continue to move in a sideways pattern—70 cents to 80 cents—with downside risk. “The futures market has been signaling that. That downside risk is at least 10 cents.”
Even with little hope for a rally, he expects U.S. acreage to increase in 2014, especially in Texas. Weakening grain prices will be a significant factor, and Texas could plant from 500,000 to 750,000 more acres, which could push U.S. acreage to 11 million, “even though it’s still dry in the Southwest. But prospects look better.”
He said with a normal abandonment, harvested would come in at about 9 million acres and production would run about 16 million bales. Export would take about 9 million bales, 1 million less than usual as China uses more of its own production. That leaves 6.4 million bales of ending stock, “double the preceding year. With a stocks-to-use ratio of 50 percent, price weakness could follow. So, I am not bullish. Expect no rally.”
He said farmrs could consider forward pricing, hedging, and options to protect some price. He also urged farmers to consider all the tools available to them—insurance, futures, options, and pools—in various combinations to find a strategy to protect against downside risk. He said options have been relatively cheap and provide price protection.
He also noted that the new programs available in the farm bill may move coverage up. “This is a new world with insurance and risk management,” he said.
He also recommended farmers look at their production costs and if they can forward price part of their crop to protect price early, they should consider it. “Don’t hedge the entire crop, just some of it,” he said.
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