Though they’re more than a dozen time zones apart, what happens with Texas’ ongoing drought and what China does in terms of rebuilding its cotton reserves will be key influences on the cotton market in the months ahead, says O.A. Cleveland, Jr.
Toss into that mix the expectation of reduced acreage worldwide and an influx of hedge fund money into the market, and “it could make for an interesting year,” he said at the annual Mississippi Farm Bureau Federation Commodity Conference at Jackson.
Cleveland, who is Extension agricultural economics professor emeritus at Mississippi State University, says the beginning of the 2012 crop year “is beginning to look somewhat like a replay of last year, in that West Texas is extremely dry. They aren’t as dry in a relative sense compared to this time a year ago; they’ve had two or three inches of rain — but as far as cotton is concerned, they’re still extremely dry.
“Memphis cotton merchant Billy Dunavant made a comment many years ago that West Texas had never made a decent cotton crop without subsoil moisture, and that has pretty much held true year-in and year-out. We saw it in spades last year, when they had only about 1 inch of rainfall during the winter.”
Long range weather patterns are suggesting that West Texas and the Southwest will remain dry, Cleveland says, and that “some of that drought is going to ease over into the Delta area and move on eastward across the entire cotton belt. So, that’s something we have to be concerned about.”
With the current cotton/soybean and cotton/corn price ratios, he says, “We would anticipate a reduction in cotton acreage this year. USDA’s model has suggested that we would drop to about 12 million planted acres, which is extremely low.
“We talked with the Congressional Budget Office and USDA’s cotton people back at the first of December, and encouraged them to bring that figure up some, to at least 12.5 million.
“People in Texas say we ought to count on 13 million — many of their producers basically don’t have an alternative for cotton, whether it be dryland or not.
“Even so, we’d anticipate a smaller crop than what we picked this current season, which means we would draw stocks down somewhat. Stocks are still extremely low, around 3 million to 3.7 million bales projected at the end of this season, August 1, 2012.”
And Cleveland says, “We would anticipate exports would be up slightly this coming season. The increase would come largely as a result of the drop we’re anticipating in planted acres in China and around the globe because of strong soybean and corn prices. We’ll probably also see China concentrate more acres on grain crops, because they’re still trying to get a better hold on their food supply situation.
“We’re not out of the woods, by any stretch of the imagination, in terms of having soybean and corn carryover supplies that the market would be comfortable with.”
The drop in cotton carryover two years ago to about a 42 million bales “was extremely low, and that’s what led to $1-$2 cotton,” Cleveland says.
China's cotton situation
“Over the last 18 months, world carryover has increased about 18 million bales — which is about the same amount the Chinese took from their strategic reserve about two years ago to fulfill their textile production needs (that’s one reason they increased their planted acres so much last year).
“We’re also starting to see are reports out of China suggesting that their current crop may be about 3 million bales lower than USDA’s figure. But it’s hard to judge this, because a couple of times in the past we’ve had similar information out of China and it turned out that USDA’s numbers were actually better.”
If the China figure is accurate, however, Cleveland says, “That may be the reason the market is now starting to move back up just a bit.”
Pakistan, India, Brazil will all reduce plantings this coming season, he says, and at the same time, “We’re seeing stronger infrastructure with respect to East Asian textile mills — Vietnam, Cambodia, Laos, Myanmar, some of these countries are starting to rival China in textile production, and are beginning to take business away from China.
“China initially got all the textile business because of their low labor costs, but as the country has developed more, the textile sector has looked to other countries with lower labor costs, and some of the business is tending to move away.
“Even so, with China’s immense population, there’s not much possibility that we’re going to see a drastic change in their mill consumption.”
China maintains a strategic reserve of cotton, Cleveland says, “simply because they need it to keep their textile mills operating. Eighteen to 24 months ago, they used basically all the cotton in that reserve, and they’ve been buying cotton to rebuild those supplies. They’ll put it in warehouses and keep it maybe six years before they ever spin it.
“They’ve already bought about 12 million bales, and will probably buy another 6 million to 8 million bales during the coming months — over and above what they need for spinning in their textile mills — in order to rebuild their reserves.”
When the market dropped below $1, Cleveland says, “China began to buy massive amounts of cotton, and they’ve continued to buy at those price levels. On Jan. 9 and Jan. 12, March cotton went below 94 cents and with each drop there were massive export sales; the Chinese bought tons of cotton on both of those drops.
“I think all this is telling us there is terrific demand out there — we’ve just got to try and find a price that will move the cotton, and it looks like 94 cents may be the point at which mills will jump all over it.
“I think we have to believe that there’s strong demand for cotton; it just hasn’t been there at $1.05 or $1.08. But now that we’ve seen all this movement below 94 cents, I think the mills will be a little friendlier toward coming back into the market. We saw that in the export sales report last week, when the mills were buying cotton for immediate delivery.”
Earlier in the year, Cleveland says, “We thought China would buy about 16 million bales of cotton, but they’ve already bought about 14 million to 15 million, and they’ve just opened a quota for another 3 million.
“So, the signals to the market indicate that there will be at least 18 million bales sold to China, and some think the figure could go as high as 25 million. That’s a little high, admittedly, but we can make an argument for it, and that would send the market somewhat higher.”
Funds reentering market
Cleveland says, “We need to understand that it took only one season to get into an excess supply situation; conversely, it would take only one season to go the other way to a tight supply. We’re certainly set up to go the other way with the drought expectations here in the U.S. and the anticipated 10 percent to 15 percent acreage reduction around the world. We could cure the excess supply situation in one season or less.”
The long term technical picture for cotton “has been somewhat bearish,” he says, “but in the last three weeks we’ve seen very large amounts of speculative money come back into the cotton market — and the market as been up, up, up.
“These huge funds are not coming into cotton looking for a penny, or two cents or four cents; they’re looking for 10 cents or 20 cents — moves that could take the market to $1.10 or $1.20.
“Several technical analysts now have positions suggesting that the market is now pointing to $1.18-$1.20, basis May/July. They are anticipating that we’ll have higher prices, based on the outlook for lower acreage here in the U.S. and worldwide.
“The funds are operating on the theory that perception is reality, and they think the charts are clearly suggesting that the price will move to $1.20. Some of the Elliott Wave theorists are looking for $1.18 on the May/July contract.”
Cleveland says he’s “somewhat optimistic about cotton in the short term, more optimistic in the long term.
“I think there’s good reason to be optimistic. We took the market down to the 85-cent level in November, which was a little bearish, and we’ve not been able to get it back above $1. It was trading at 98-99 cents today (Jan. 23).
“Last week saw extremely strong export sales relative to what we had expected, 190,000-200,000 bales — much better than the 50,000 to 60,000 we’d seen for several weeks, and before that we went for two months with negative sales due to cancellations.”
Cleveland says he hadn’t thought cotton would drop to the 85-cent level it hit in November, and “I think most chartists’ opinions are that it was a drop-dead bottom.
“I think we can be very positive about cotton. But, if we get a lot of rain in West Texas over the next two months and plenty of moisture everywhere else, then we’d have to be concerned about the possibility of staying around 88 cents to 90 cents, with a potential range of 85 cents on the low end to $1.20 on the high end.
“I think we can make a realistic case for the market not going below 85 cents. I think it’s going to be easier to take it up to 98-99 cents than to take it down to 85 cents — but we can’t write off a drop to 85.
“There’s a lot of demand out there — we just haven’t been able to get the price where the mills would begin to buy. The anticipation now is that they seem a little better off, despite all the negative things we read about the economy, and that pent-up demand from consumers is slowly coming back into the market.
“We’ve seen a firm base for demand, but supply, in the short and medium term, is going to be more important than demand. If they get a lot of rain in West Texas, it’s going to take the market down.”