Cotton prices have firmed up toward the high end of the recent, relatively tight range. In an environment in which many of the commodity bull markets – such as some of the grains and softs – may be unraveling, cotton has been a standout. And on the surface, its resilience is counterintuitive.
The Dec. 11 monthly USDA crop report was actually friendly for cotton prices. Ending stocks for 2011-12 were revised down by 450,000 bales. A small increase in the 2012-13 production estimate was overshadowed by an even larger increase in consumption. As a result, the estimate for 2012-13 ending stocks was revised downwards by 630,000 bales, to 79.64 million bales, or 74.8% of usage, down from last month’s estimate of 75.49%. However, that figure still represents burdensome inventories. We are still much higher than last year’s 67% of usage and dramatically above the 10-year average of 51%.
Market participants have had the opportunity to digest all the information regarding the size and quality of the new crops, which must last through to Autumn 2013. In addition, they’ve had a chance to contemplate the monstrous global stockpiles. And yet the market has built a base that stretches back to early summer and seems to defy the implications of the supply/demand fundamentals.
U.S. exports have been steady, but not overwhelming. Average weekly commitments since the beginning of November have been 338,000 bales, which is above average for this time of year. Total year-to-date commitments, however, stand at 7.8 million bales, down about 20% from last year at this time. Last year there were a few weeks of extraordinary sales, and then the market sputtered, with little new-sales activity for the balance of the marketing year.
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.