According to official statistics – which is the same data used for the USDA balance sheet – the Chinese have ample stocks. So it’s a bit puzzling why they have been buying cotton abroad. The strength of U.S. exports hinges almost exclusively on Chinese purchases. It remains to be seen if their enigmatic buying will continue. Demand is a wildcard.
As we discussed in the Oct. 25 issue of Focus on Futures, cotton prices may remain high in historical terms, but they are actually very unattractive for farmers, for two reasons. First, current prices can’t be compared with the pre-2008 period, because production costs have skyrocketed. At current prices, profit margins are very slim. More significantly, while grain prices have come off their highs, it is still more profitable to plant corn, soybeans and wheat. There is talk that in some regions farmers will plant 50% fewer acres to cotton than they did last season. Some analysts are forecasting that total U.S. cotton area will fall by close to 30% from last year’s12.36 million acres, which would be a 30-year low.
Furthermore, even if the gap between cotton prices and alternative crops narrows over the next couple of months, there is a point at which the window for cotton planting closes. Corn and soybean plantings require investment in seed, and for regions where corn and soybeans are planted early, that investment is usually made by early February. At that point, farmers will not return to cotton. The longer cotton prices remain confined to the present range, the more probable a dramatic fall in acreage becomes. These economic realities are likely to prevail among other cotton-growing nations.
As we mentioned, it’s hard to know whether demand can snap back to 2010-11 levels. If it does not, we still don’t think prices will fall much further, because the shift from overproduction to underproduction is expected to happen in just one season. If demand surprises, look for much higher prices.
We advised rolling long positions in the December 2012 contract all the way to new-crop December 2013. The near months could be more vulnerable to an abrupt halt in Chinese buying. Next year’s crop month will be more reflective of the much smaller output we expect to see next year.
Maintain sell stops at 72.5¢ per pound, basis December 2013, close only.