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Currency, carryovers: Trends point to higher cotton prices

Have cotton futures made their annual January run-up only to head back into the doldrums for the remainder of 2003?

Maybe and maybe not. One veteran analyst believes several developments are pointing to a potential turnaround for cotton prices that could bode well for an industry that has been short of good news in recent years.

Woods Eastland, president and CEO of the Greenwood, Miss.-based Staple Cotton Cooperative Association, cited three bullish trends that could be positive for cotton in remarks at the Beltwide Cotton Conferences in Nashville, Tenn.

Looking at the demand for cotton in the 2003/04 marketing year, Eastland made the following observations:

He believes the decline in the value of the U.S. dollar that began in January of 2002 will continue, probably for several years. “For 2003, that will help the domestic textile industry maintain its consumption at 2002's level of 7.5 million bales, and we will probably be able to increase consumption from there in future years,” he noted.

USDA's projection of a 40 percent stocks-to-use ratio at the end of the 2002/03 marketing year (July 31) is the lowest since 1994's 35 percent. That was the last time cotton prices rose above $1 per pound.

Because of the shortage of middling 1-3/32nd-inch cotton due to the weather problems in the U.S. Cotton Belt and in Australia, the size of the Step 2 marketing certificate has continued to increase in 2002/03. The larger subsidy will help U.S. cotton to continue to move into export channels and create an additional source of revenue for the U.S. textile industry, he believes.

Eastland said that when you look at the trendline for the last 30 years, fluctuations in the value of the dollar appear to move in inverse proportion to U.S. domestic mill consumption.

“Between 1979 and 1985, the dollar appreciated tremendously,” he told participants in the Beltwide Economics and Marketing Conference. “Then, from a high in 1985, the dollar depreciated for a 10-year period to a low in 1995. From that point, the dollar appreciated for six years to a high in 2001 about equal to where it was in 1976.”

From the end of 2001 until early January when he spoke in Nashville, the value of the dollar as measured by the Federal Reserve Dollar Index has fallen by a little less than 10 percent, Eastland noted.

“Before the crisis in U.S. mill consumption that developed beginning in the late 1990s, the one prior crisis in the last 30 years was in the mid-1980s,” he said. “This crisis was what helped engender the advent of the marketing loan for cotton in the 1985 farm bill.”

As the dollar deteriorated from that high in 1985, U.S. mill consumption grew conversely so that its peak in the 1996/97 season corresponded with the low for the U.S. dollar, says Eastland. Since then, the dollar's six years of appreciation have been matched year for year by a six-year decline in domestic consumption.

“We think because of current trends in monetary and fiscal policy in the United States and in several of the world's major economies, we will see the decline in the dollar that began last January continue, probably for a multi-year period.”

USDA's forecast of a drop in world carryover as a percentage of world consumption also could be a positive sign, says Eastland, who displayed a chart of the Agriculture Department's carryover projections since 1994.

Eastland said he began the chart with carryover from the 1994 crop because that 1994 ratio of world carryover equal to 35 percent of world consumption “we think is an important benchmark.

“1994 was the year when cotton prices went over $1 a pound,” he noted. “They went that high because consumption during the fall, winter and spring of that season was so high that it left a real prospect of not enough cotton being available to run the mills of the world until new crop became readily available during the late fall of 1995.

“The market always makes sure that enough cotton is available, and it did in 1994 by going above $1 per pound to suppress demand.”

Eastland said he believes the number of bales in inventory on July 31, 1995, was the absolute minimum that the world's mills required in order to run until the new crop would be available.

“Thus, we think that the 35 percent stocks-to-consumption ratio of that year is a good proxy of the minimum amount of cotton that the world requires each July 31,” he said. “USDA's projection of 40 percent stocks to consumption is the lowest since the 1994 crop. This implies strong demand for all the world's exporters including the United States.”

The same situation holds true for Step 2 certificates because of a shortage of “white grades” due to a shorter staple crop in Texas, rains in the Mid-South and Southeast and the Australian drought.

“The size of the Step 2 certificate has continued to increase in the 2002/03 marketing year even as the spread between the adjusted world price and New York futures has collapsed,” he noted. “This larger subsidy will help to continue to move U.S. cotton in export channels briskly and create more revenues for U.S. textile mills.”

For all those reasons, Eastland believes, short-term (nine to 12 months) prices will be determined by the size of the 2003 U.S. crop.

“If everything else in the world is as predicted, a U.S. crop prediction of around 17 million bales or below would be bullish for prices and could be very bullish,” he says. “If you look at the trends in the exchange rate of the U.S. dollar, and in the world carryover of cotton, then you must assume that it is most likely that the risk of error is that prices will be more bullish than most currently think.”

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