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Corn+Soybean Digest

Hold Tight On Marketing Cotton

Randy Darnell had an early season cotton marketing goal of 60¢/lb. cash. He didn't reach it. Neither did many other growers.

But with forecasts of stronger prices, even unseasonably leading into harvest, Darnell and other growers might get close to that goal with a good chance to see even better prices into 2007, say two Texas A&M University economists.

“With the expectation of a decrease in our carryover stocks and the potential for a small U.S. crop, the market should gain good support into the 60¢ level,” says Anderson, Texas A&M economics professor emeritus at College Station.

“Reduced stocks and other fundamentals could lead to higher prices,” adds Jackie Smith, Texas Extension economist at Lubbock.

With a glut of cotton still in the pipeline and early year projections for another large U.S. crop, there were few opportunities to lock in a good price earlier this year. December 2006 futures prices remained low, in the low-50¢ range in mid-summer, even after Texas drought threatened to reduce harvested acres by 2 million in Texas alone. Also, factor in poor growing conditions in dry areas across much of the Delta and southeastern production area.

“I never got any of my cotton marketed early because we didn't reach our goal of marketing cotton at cash in the low- to mid-60s,” says Darnell, an Amarillo, TX, grower, who also produces wheat and runs stocker cattle. “We typically begin to market out front when prices approach 60¢ net back to me. That didn't happen this year (in early spring through mid-summer).”

Since his local market basis is about minus 7-8¢, a cash price near 60¢ means futures must push the 66-68¢ range.

He sometimes uses futures or options to set a floor price, but most of his marketing is through his local Top of Texas Gin, which takes part in a regional marketing pool. He likes the pool because he receives an “act of God” clause. “I basically contract in acres and not in pounds,” he says, “based on a perceived yield of a field throughout the growing season.

“In late summer or early fall, if we see December futures in the low- to mid-60s range, I might go ahead and market some,” Darnell says.

That would give him a cash price in the high 50s, lower than he normally shoots for, but possibly a high price between late summer and late this year.

Anderson and Smith normally advise growers to look hard at locking in some sales when December '06 cotton futures edge above the 60¢/lb. range.

Anderson says the key to improving income is “to anticipate market moves in advance and use strategies to insure against adverse price moves.” But he admits that practice has been easier said than done this year because the fundamentals have not taken normal routes to higher prices.

“The fundamentals are competing with things new to the market,” he says, such as record high open interest in New York Board of Trade cotton futures (over 121,000 for December '06 alone). “And now that the U.S. depends so much on exports and exports depend on China, we are looking at new dimensions in the market. It's a complex mix.”

Nonetheless, there are signs that prices should increase. Projections that cotton prices likely could see major upturns in the next few months and next year have been based on a potential reduction in world production and an increase in consumption.

In early summer, the International Cotton Advisory Committee reported that world cotton production was forecast at 115 million bales for the 2006-07 marketing year (new-crop cotton), compared to 114 million bales for '05-06, and steadily lower than the 120 million bales for '04-05.

At the same time, the committee forecasted world cotton consumption at 118 million bales for '06-07, above the 115 million for '05-06 and 107.8 million in '04-05. World ending stocks were projected at 46 million bales for '06-07, down from 50 million bales for '05-06 and from 50.3 million from '04-05.

The committee's A Index price projection is 69¢ for '06-07 marketing year. That compares to the '05-06 projected A Index price of 56¢ and 52¢ (U.S. loan level price) for '04-05.

“We hope that fall prices will rally up to 60¢ or higher,” says Anderson. “If that happens, growers need to consider fixing that price (with futures, options or forward contracts) on some of their crop.

“But don't wait too long. With our world of market uncertainties, the ability to a set a floor under a price may be very short lived, maybe even a day or less.”

Protect Your CCP

With the projections for higher prices next year, it may be time to consider using '07 call options to protect the government Counter-Cyclical Payment (CCP).

In mid-summer, with December '06 futures prices in the low to mid-50¢ range, virtually a maximum CCP was available, but only while prices remained low, says Jackie Smith, Texas A&M Extension economist at Lubbock.

Remember, the maximum CCP is 13.73¢/lb., and only on base acres enrolled in the farm program, and only on 85% of those. The maximum CCP occurs when the market price is below the 52¢ government loan.

CCP is calculated at the beginning of August in one year and ending in July of the following year. So if market prices remain low through harvest and into the heart of the following year, the high CCP is available. It's based on the average of all bales sold during the marketing year. This means the CCP rate is determined mostly in the months when most of the cotton is sold. Usually about 70% of cotton is sold by producers in early spring.

But once market prices start moving up, as is projected for the next year, then the CCP starts to decline.

Producers who have the cotton will see the CCP reduction made up in a higher market price. However, if part or all of the cotton base was hailed-out or damaged from drought or other disaster, and a “catch-crop” is replanted, the grower does not have the cotton to sell at a higher price to make up for the lower CCP, says Smith.

A sample call strategy would be for a grower to buy March '07 call options at the 56¢ range for about a 2¢ premium, says Smith. If the market goes up toward harvest, which many think it will, the grower could take advantage of the increased income provided by the higher futures price and, thus, the 56¢ call strike price.

“For the grower who was hailed-out and planted another crop, the call will gain value as if he had a cotton crop,” says Smith.

“We're in a situation where growers should consider protecting their CCP,” adds Carl Anderson, Texas A&M economics professor emeritus. “But I would make sure to try and hold the cost of the call option down. I don't believe in spending 4¢ to possibly make 5¢.”

Smith reminds growers that in normal years about 70% of the CCP has been made by March, so delaying the call strategy might take away from potential profits.

He and Anderson suggest visiting with local and regional Extension economists to better understand how the CCP program, and the method of protecting it from higher market prices, can benefit a grower's bottom line.

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