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Volcot analyst says: Debt, oil prices could slow cotton use

Runaway consumer debt and high oil prices are threatening to slow world cotton consumption in the coming year, according to Peter Egli, an analyst with Volcot America, Inc.

Egli, speaking at the Ag Market Network's May teleconference, said this factor, plus bigger world crops are expected to push world cotton ending stocks higher in 2004-05. However, current U.S. stocks are still at dangerously low levels, meaning nasty weather could lead to price spikes this summer.

Egli agrees with USDA's assessment that the world's largest cotton crop ever, at 102.5 million bales, could be right around the corner. If achieved, this would mark the first time that a world crop has gone over 100 million bales.

According to Egli, the biggest increases in production will come from China, up 5.5 million bales from the previous year; India, up 1.5 million bales; Pakistan, up 700,000 bales; and Australia, up 1.1 million bales.

The United States is the only major producer likely to produce a smaller crop this year. “We believe that it may be around 17.3 million bales, based on 13.56 million acres,” Egli said.

“We don't believe the record average yield of 725 pounds can be repeated because we have a higher proportion of Texas acreage (where yields are typically lower) versus Mid-South-Southeast acreage (where high soybean prices have led a shift away from cotton).”

Egli estimates an average yield of 670 pounds and an abandonment of 9 percent for U.S. growers.

Egli is less optimistic than USDA about world consumption for the coming year, pegging it at 97 million bales, 2 million bales less than USDA's forecast.

One reason, U.S. consumers are up to their eyeballs in debt and are about to hit the wall.

“U.S. households have added $2.4 trillion dollars of debt since 2000, from $7.1 trillion to $9.5 trillion,” Egli said. “It's really the U.S. consumer, assisted by the U.S. Federal Reserve's easy money policy and government tax cuts that has kept the U.S. and the global economy afloat the last few years. This is about to come to an end. Inflation is starting to rear its ugly head and interest rates are creeping up.”

This could come as a double whammy for consumers, according to the analyst. “High interest rates means consumers will have to pay more to service their debt burden. This will probably put the cap on real estate prices and limit the consumers' ability to use their homes like ATM machines.”

For example, “over the last two years, homeowners have cashed out over $400 billion worth in home equity loans and cash-out refinancings. An over-extended consumer in a slowing housing market could spell trouble for cotton consumption.

“For every home that is sold, the proud new owners are likely going to buy new towels, bedsheets, curtains, etc.,” Egli explained. “Keep in mind that the American consumer purchases nearly one in four bales at the end use level worldwide, and have contributed 50 percent to the growth in cotton consumption over the last 10 years. We need to keep a watchful eye on these developments.

“Adding insult to injury are high gasoline prices,” Egli noted. “In the United States, we consume about 380 million gallons of gas per day, and a 50-cent per gallon increase translates into an additional $190 million per day. This is taking discretionary spending power out of the consumer's pocket.

“Higher energy costs also are feeding into other areas, including the cost of farming.”

Egli agrees with USDA's forecast of 5.8 million bales of domestic mill use for 2004-05, but he believes that U.S. exports will fall off from last year, below USDA's current forecast of 11.5 million bales.

“USDA is projecting a foreign production gap of 8.3 million bales, considerably down from last year's 17 million bale deficit. I believe that the United States will export only 10.5 million to 11 million bales.”

Most of the world stock building will take place outside of the United States next year, according to Egli. “U.S. stocks will only go up 300,000 bales, while the rest of the world will rise 3.2 million bales.

Because of the much smaller production gap, “we face increased competition from Australia and Brazil,” Egli said. “The United States will have a much tougher battle on its hands. Another handicap for the United States is the higher percentage of west Texas cotton next season, which is not the preferred choice abroad.”

China will continue to import cotton, but it will be on a much smaller scale, unless they have another crop problem, the analyst said. “Our best estimate is that Chinese imports will come in at 4.5 million bales, with the U.S. marketshare at about 2.5 million to 3 million bales.”

World ending stocks for the new year will be higher than USDA projections, according to Egli, who pegs them at 37.8 million bales for the world and 4.5 million bales for the United States.

Cotton prices for the coming season will fall into two categories based on quality, according to Egli — strict low middling, 34 staple cotton represented by the futures market and higher quality 36 staple cotton represented by the cash market.

“Beginning stocks for next season will consist to a large degree of strict low middling (34 staple) cotton, while there will be relatively few middlings around with the exception of Brazil. Therefore, I believe that the basis for middling cotton will remain very strong next season.

“The fact that we have such low ending stocks will have the market on edge for the next five months or so,” Egli added. “Any hiccup on the production side will lead to sharp rallies. At the least, we should see some increased volatility.”


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