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China's conundrum, buying high, selling low

China's conundrum, buying high, selling low

China wants to work down its cotton stocks. How it will proceed is anyone's guess.

The idea of buying low and selling high never quite caught on in the curious world of Chinese cotton stockpiling. And now the Chinese government is stuck in a quandary – how to sell a huge surplus of cotton stocks it purchased for well over $1.25 a pound into a market offering much less.

This is the dynamic that will hang over the world cotton market for the next couple of years, according to Jarral Neeper, president of Calcot, speaking at the 2014 Beltwide Cotton Conference in New Orleans.

“We have excessively large world stocks around the world,” Neeper said. “From 2010-13, world production has exceeded consumption by 50 million bale equivalents. You can see what kind of impact that has had on world ending stocks, threatening 96 million to 97 million bales of cotton.”

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Much of the surplus is in China, which purchased nearly 44 million bales of cotton over the last few years despite falling consumption in China and around the world. As a result, “Chinese ending stocks have increased rather dramatically and are expected to be to 60 million bales by the end of this crop year. Stocks in the rest of the world outside of China are going down. They’re large, but at least they’re still going down.”

With China’s surplus effectively held off the market, prices haven’t collapsed as one might expect, Neeper said. But now the time has come to do something, and China is stuck.

“They don’t know what to do,” Neeper said. “They don’t know how to get out of the vice that they’re in.”

It appears now that China intends to sell some of its cotton, although Neeper believe China will remain cautious about doing anything that could cause a price collapse.

“They’ve sold a little bit of cotton, although not nearly as much as they wanted to.”

China will likely cut back on cotton imports, Neeper said. “I’m estimating 6 million bales in imports in 2014-15, which means that exports from the United States, India and other countries are going to be down rather severely.”

Stagnant yarn prices and excess polyester capacity are also concerns for the cotton market, Neeper said. “During the big run-up in prices in 2010, when cotton prices really took off, yarn prices tried to follow but they didn’t do great job of following completely, and that’s one reason why polyester has taken over some market share from cotton.

Flat polyester prices are keeping a floor under cotton prices, Neeper says. While cotton prices are maintaining a premium to polyester, “it’s very difficult to get much above where these polyester prices are sitting.”

On the bullish side, Neeper said that speculative money “has jumped back into cotton. They see something that they like. It’s mostly technically driven, but certainly it’s helping prices come alive.

A smaller U.S. crop and ending stocks are also bullish for prices. “U.S. production of 13.1 million bales in 2013 is this third smallest since 1988.”

Neeper suggest a broad range of cotton futures prices between 69 cents and 94 cents a pound. “But I believe were going to spend a lot of time trading in the 76 cent to 88-cent range. Once you get around 84-85 cents, interest from mills to buy cotton starts dropping rather dramatically. As you drop back toward 80 cents and below, it starts picking up.”

For 2014-15, Neeper projects world area to decline about 3.5 percent and world production at about 111 million bales, a six million bale decline from 2013-14. He projects U.S production at 16.4 million bales, on a 5 percent increase in plantings, and Chinese production at 26 million bales. “Cotton will gain a little bit in terms of market share. Look for world consumption to increase to around 114 million bales.

“We will slowly start to work off stocks. Pricing expectations are very difficult to project in the current environment, and polyester is still going to be problematical.”

Neeper sees an increase in cotton acres in the Mid-South and Southeast in 2014. “With better moisture conditions, we will hopefully also see a slight increase in plantings in Texas, Oklahoma and Kansas.”

Neeper projects a 12 percent decline in plantings in California, but that may be optimistic because of this year’s poor snow pack, about 20 percent of normal. “In the Far West, we’re suffering from a third consecutive year of drought. Arizona is not as bad off water wise as California.”

With higher production in the United States, 9 million bales of exports and 3.9 million bales in domestic consumption, Neeper expects U.S. ending stocks to increase from 3 million bales to 6.5 million bales.

“The biggest unknown obviously is what China will do. China has said that they do not want to be responsible for a complete collapse in world cotton prices. So even though I’m painting a rather negative picture, the Chinese government may decide to do things differently going forward, and it may not be as negative as we think.”

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