November 26, 2018
Cotton production losses and their effect on U.S. production estimates from Hurricanes Michael and Florence have yet to be realized. A booming economy and a surplus of cotton leave growers wondering about the cotton market risks going into the 2019 season.
Texas A&M Economist Dr. John Robinson examined these supply and demand issues along with risk management considerations, in a recent webinar produced by the University of Arkansas System Division of Agriculture.
On the supply side, while the November WASDE report partially accounted for production losses caused by the hurricanes, Robinson expects more to come. “I wouldn’t be surprised to have the next report and maybe the next two still whittle away at the U.S. production estimate as the USDA figures out how many bales were actually lost during those storm events.”
But the main concern with supply and demand lies on the demand side: “Is demand slowing or are we in a temporary lull?” Robinson asked.
“The demand for grain crops has been largely unaffected by things that affect cotton demand,” he says, “mainly because there’s a growing class of people who are becoming wealthy in some of the developing countries. The first thing they do is improve their diets, eating grains and meats — grain fed meat — which has led to a major expansion, an upward trend in per capita of grain consumption.”
But that’s not true of cotton. As the economy goes, so goes cotton consumption. “Cotton is more of an industrial crop and it’s related to retail purchases of apparel and home furnishings. They’re discretionary items, and they go up and down with the economy.”
And while U.S. economic growth has increased more than 3 percent in the last two years, and the stock market was up until a few months ago, Robinson says today the U.S. is not in a boom time and the long-term projections suggest slower economic growth.
“So, I’m not looking for a major boom in economic growth and in people’s wealth to stimulate large purchases of more cotton than we were expecting.”
Historically, when the U.S. is in a recession, per capita cotton consumption drops. “When people tighten their belts, they don’t have to buy new clothes. They don’t have to buy new towels and sheets, but they do have to buy gas. We put food on the table and gas in the car, so people prioritize,” says Robinson.
From January through June of 2018, U.S. export sales were “unusually large,” adding to the bullish market sentiment, says Robinson. “At the same time, a major drought was going on in Texas, Oklahoma and New Mexico and in other parts of the Cotton Belt, so, between concerns about supply and rather strong sustained, robust export sales, things were looking pretty good and that’s when we had prices rally steadily all spring, all through the first and second quarter of the year on up into the '90s.”
But since June, those unusually large export sales have become somewhat stale. “It’s slacked off. We’ve been at a recent pattern of somewhat anemic export sales,” Robinson says.
The culprit? Along with several other factors, Robinson points to tariff uncertainty with China and issues in Turkey. “They (Turkey) have political upheaval; their currency has collapsed; their trade has been disrupted and that’s probably curtailed what otherwise would have been normal sales of U.S. cotton to them. Then the problems with the crop and the uncertainty of quality supplies may have put a damper on U.S. exports.”
The most influential factor when it comes to upward and downward movement of cotton future prices, is speculators. “If they think the market’s going down, they’ll sell it trying to take advantage of that trend, and if they think the market’s going up, they’ll buy it. Speculators tend to be a catalyst and a sort of self-fulfilling prophecy influence.”
Since 2016, the U.S. has had varying, but large, positive amounts of net buying by hedge fund buyers, but during 2018, the rise in prices during the first and second quarters of the year, combined with the peak in prices in the mid-90s has resulted in a major buildup of hedge fund longs. “And consequently, when those people down-shifted out of that peak position, prices came back down into the 80s and then below 80 cents to where they are today, 77 cents per pound.
“So, they’re a major influence,” says Robinson, who adds that the last major downshift in the market was associated with the recent announcements about tariff retaliations between the U.S. and China.
“I think it had something to do with the mindset of these speculators and getting out of that uncertain situation, which contributed to a decline in prices.”
When retaliatory tariffs were announced this spring, as has been the pattern for the last five years when China distorts markets, cotton export sales typically do not decrease but are only rerouted to countries like Vietnam, Indonesia, Bangladesh and Pakistan for spinning and then shipped to China duty-free.
“That was what I expected to happen,” says Robinson. “But in the last round of tit-for-tat announcements back in September, the U.S. imposed a large round of tariffs on selected Chinese imports and they included apparel. China’s responsible for about 40 percent of the apparel imports into the United States and about 30 percent of the cotton-dominated apparel imports into the United States.
“So, if we impose tariffs on Chinese imports in the short run, we’re probably making it more expensive for U.S. consumers to buy cotton-dominant apparel. We’re raising the price of it, which in theory would reduce the quantity demanded of it. And that may work its way back down the supply chain to reduce Chinese demand for cotton in general, not just for U.S cotton.”
An indirect effect of the tariffs on the cotton futures market is with hedge funds downshifting out of their long positions because of uncertainty about the impact of this whole ordeal, adds Robinson.
Bottom line, U.S. tariffs slow growth, whether on China, Canada or Mexico. “Tariffs are a tax on consumers, which ultimately results in slower growth to the extent that the GDP is lower and cotton consumption is lower.”
The main situation Robinson says colors his outlook of 2019 is the “very big” cotton supply.
“I think we’re going to plant just as much if not more cotton in 2019. And that’s because grain prices are lower relative to cotton prices — it favors cotton over wheat and cotton over feed grains. Soybean prices have collapsed and that may increase cotton plantings as a substitute in the Mid-South and in the Southeast.”
Excess soil moisture this fall, along with El Niño conditions forecast, which usually means rainier, wetter weather during the spring into summer, will likely result in lower abandonment, higher yields, potentially excess production, he says.
“I’m worried about a supply response, which is economic code for weak prices as a result of excess supplies,” Robinson explains.
Should the above scenarios play out, Robinson recommends growers consider ways to remove downside price risk.
“While prices are still good — we have futures in the upper 70s — I would ask growers to consider forward contracting a reliable amount, a portion of their expected production or their guaranteed production; they could use their APH’s, and forward contract at these levels.”
Robinson also encourages growers to take advantage of rallies in the market to do some pricing. “At the same time, you can forward contract a portion. You could also consider just hedging a portion and hedging earlier than you’re used to but either using a hedge selling futures, which has its risks, or using put options strategies, but I would consider hedging a portion, especially if there’s a rally in the market, or using put option strategies at a given level of prices would only get a little bit cheaper and be ready to act.”
Three ways Robinson recommends growers be ready to act:
Have an established relationship with your merchant buyer.
Have an established account with a reliable futures broker who knows about ag commodities and specifically cotton.
Respond when there are quick bursts of upward volatility in the market because when they are spec driven, they don’t last very long, he adds.
For updated examples, refer to Robinson's online newsletter: The Cotton Marketing Planner Newsletter.
Another risk management tool Robinson recommends is insurance and using the Insurance Decision Aid tool, under “Economic Models,” and “Farm Program and Insurance Decision Aid,” to help in making that decision.
“You can input all of your different operations and your APH histories and the locations, the county of those operations and it will consider the thousands of combinations of insurance products you can think of,” says Robinson. “It’s something that lets you sort through a selection of them, maybe print them out and take them to your crop insurance salesperson and give you a basis to asking some questions.”
To view the seminar, Cotton Market and Risk Management, click here.
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