Cleveland: Cotton Market Chess
Economist O.A. Cleveland takes issue with some bearish cotton market projections from the ICAC.
September 4, 2012
Cotton prices were up and down all week as competing fundamentals moved the market as if it were a chess game. Nevertheless, the market was up about 200 points at week’s end. Hurricane Isaac’s negative impact on the Mid-South and Southeast crops, a decent weekly export sales report, a lower dollar, an increase in long futures positions by managed money funds, lingering concerns regarding the drought reduced crops in both India and the U.S., and improved retail sales in major apparel stores were positive fundamental news behind the price increase.
Acting to hold prices in check were the long expressed concern regarding Chinese textile demand for raw cotton and the International Cotton Advisory Committee’s (ICAC) announcement that its estimate of the average annual A-Index price would be between 60 and 80 cents. An A-Index of only 60 cents would portend an average New York futures price of only about 48-53 cents (and in Ripley’s Believe it or Not a cash price near the CCC loan). The upper end, 80 cents, would portend an average New York futures price of some 68 to73 cents. These price estimates are by far the lowest of any organization that predicts cotton prices. Possibly, should the Alaskan grizzly bears invade the lower 48, then world average price prediction of 80 cents could come about, but it will take a whole bunch of bears to push prices that low.
December futures continue to hover at the 100 day moving average and need to cross and hold above the 77.50 cent mark to verify that a new and higher trading range has been established. Questionable economic indicators, especially in Europe, coupled with the upcoming fall harvest in the Northern Hemisphere, will keep a lid on price activity, but a challenge of the 80 cents market is still the goal of this market. The upper limit of 85 cents is likely out of the realm of reason, but cannot be discounted until the size of the Indian and U.S. crops are much better defined.
All agree that a combination of the Indian crop size and the political decision that China will make regarding its vast horde of cotton stocks – forty percent of the world total—hold the outcome to price direction. While the monsoon is improving in India, too much time has been lost and the crop will be severely reduced.
China faces a major dilemma. Its price paid to farmers is some 10-15 cents more than the price domestic Chinese textile mills can buy cotton on the international market. However, the government only allows the textile mills to purchase limited quantities of cotton for import. Thus, the cheaper imported cotton substitutes for the more expensive local cotton and forces the government to purchase, for inventory, the local cotton. Chinese mills, if they have to use local cotton, pay more and, thus, their yarn/apparel production is not as competitive as that produced in other Asian-Subcontinent countries. Thus, China’s textile production shrinks as other countries take market share from them.
The Chinese dilemma is between paying more than world price to growers and having excessive government subsidies, or to allow textile mills to import cotton so as to remain competitive. To date, the Chinese have continued to support the grower price at the expense of losing textile market share. All signals point to a continuation of that policy, as they feel that the decline in textile operations will be slow. Yet, it is interesting to note that new mills coming online in other Asian countries are generally owned by Chinese textile companies. Of course, this was the same path the U.S. followed in the late 1900s and early 2000s as yarn mills closed U.S. plants and opened new operations in Mexico. Thus, for growers, China has a political incentive to keep cotton above the world price. This artificially increases the world price of cotton and is one reason we hear so much bearish news regarding Chinese consumption. Chinese consumption is under pressure, not from the consumer, but from other textile producing countries.
These reasons, coupled with the economic fact that cotton must compete with grains and oilseed for acreage, will support cotton prices at a level higher than that suggested by the ICAC. This is not to reflect negatively on ICAC. Since the early 1990s the organization has risen to become one of the world’s premiere groups involved in analyzing cotton fundamentals—and remains so today. New York should continue to see a yearly high low range of 70 to 85 cents.