The cotton market faces two huge uncertainties in the short-term, according to Joe Nicosia, CEO of Allenberg Cotton Co. One is how to deal with the hangover left after high cotton prices of 2010-11 contracted global demand. Another is uncertainty over what China will eventually do with cotton in its strategic reserve program.

Speaking at the Mid-South Farm and Gin Show, Nicosia pointed out that prior to last cotton-growing season, the market pushed for more acres, with prices between $1.30 and $1.50 pound. The world responded with higher plantings.

“But one factor we did not see coming was the demand drop,” Nicosia said. “It came in around the 110 million-bale level from what was projected at around 119 million bales. This created a huge surplus. The crop we just had was massively bigger than consumption, despite some major production catastrophes around the world, including Texas.”

The 9.3 million-bale drop in world cotton demand was due to two factors, according to Nicosia. Due to high prices, mills switched to synthetic fibers for many uses, particularly for non-apparel uses. At the same time, economies weakened and total off take decreased. World carryout has climbed from a projected 41.6 million bales in April 2011 to almost 61 million bales.

“Whether cotton regains market share from synthetic uses will be the key to future demand,” Nicosia said.

Another factor is how China will operate its reserve purchase program,” Nicosia said. “As long as China keeps building its reserve, it supports prices in the short term, but dampens the long-term chances for upside price moves.”

Nicosia says China will end with between 16.5 million and 18.5 million bales in the reserve. “That means the free stocks in the world, those available for use, are going to get very tight, almost as tight as last year. The question is whether we focus on large world stocks or tight free stocks.

Nicosia reported that in late February, China announced a $1.27 price for its reserve program. “That’s pretty high. That doesn’t necessarily mean that’s where we go with prices. But it’s important enough that I’m going to call it an anchor point. It gives us some relevance.”

Another important factor is how China deals with the stocks they hold, Nicosia said. “It will be critical for the world price level and the price U.S. producers will receive for cotton. What will China do? I’m not sure. But what I do know is that today, China has bought enough of its domestic cotton that they have roughly an 8 million-bale deficit to get through the year.”

To resolve that issue, “they have to sell their reserve or they have to import cotton. Those are the decisions they are struggling with.”

Nicosia said the Chinese have not purchased Indian cotton for its reserve citing quality reasons.

He added that the size of the Indian crop remains uncertain. “The Indian government has shown it may embargo exports if necessary. If Indian availability is choked off, it would be a boon to other export growths.”

As to whether cotton demand has been deferred or lost due to high prices, Nicosia said, “Many thought that as new crop supplies came into the market at cheaper prices, we would see consumption move up fairly substantially. That hasn’t been the case. Poor business conditions around the world, recession and the problems in the European Union have retarded consumption. We’ve seen consumption drop to recession levels of 2008-09. Man-made fiber has taken a substantial bite out of cotton consumption.”

Nicosia sees a potential drop in world cotton area for 2012-13. “Today’s 90-cent cotton market will not achieve the same result as the $1.25 to $1.50 market did in 2011. Nevertheless, with the decline we have seen in demand, we do not need another year of record area to be assured of a surplus.”

Nicosia advised producers to market what is left of old crop cotton on rallies. The largest single value for 2012-13 will likely be the effect of rainfall in west Texas, according to Nicosia. “For 2012-13, when the market provides you the chance to lock in a desirable return, take it. If you want to speculate on longer-term higher prices, buy a call.”