May 2012

Cotton prices moved lower over the past month, and fell sharply with the release of the USDA's May report. The July New York futures contract fell from 93 cents/lb in late April to values below 82 cents/lb in the most recent trading The December 2012 contract, which is important since it reflects price expectations following the upcoming harvest, fell below 80 cents/lb. Prices for both futures contracts are close to life of contract lows. The A Index, which had been holding to a tight range around 100 cents/lb, dropped below 95 cents/lb to its lowest values of the 2012 calendar year. A variety of reasons could be behind the decreases, including India's elimination of restrictions on fiber exports, rain in West Texas, and less positive economic data in the U.S. and Europe. All of which suggest loosening fundamentals.

The May USDA report is the first to include a complete set of supply and demand forecasts for an upcoming crop year, and these estimates indicate supplies will continue to be plentiful in 2012/13. At the conclusion of 2011/12, the USDA estimates that a record 66.9 million bales will be carried forward as ending stocks. In 2012/13, the USDA expects ending stocks to swell another 6.9 million bales to 73.7 million bales. This record volume of ending stocks is expected to produce a record stocks-to-use ratio. In 2012/13, the stocks-to-use ratio is projected to climb to 67.1%. The current stocks-to-use figure for 2011/12 is 62.8%, which is only marginally below the existing record of 63.2% set in 1985/86.

Recent increases in world cotton supply can be seen as a product of market forces resulting from the spike in prices that occurred in 2010/11. Prices peaked in the spring of 2011, coincident with planting decisions for northern hemisphere countries. This led to both record cotton acreage and a record cotton harvest in the 2011/12 crop year. High prices also caused a reduction in demand. World fiber consumption in 2011/12 was lower than in 2008/09, the crop year concurrent with the worst of the global recession. In 2012/13, effects of 2010/11 prices on the global supply and demand situation are expected to begin to diminish. World production is expected to decline 5.2%, falling from 123.0 to 116.7 million bales. Both global economic growth and recovery of market share relative to synthetic fibers are expected to bring world cotton consumption 3.3% higher in 2012/13, from 106.5 to 110.0 million bales.

At the country-level, the largest production decreases are forecast to take place in China (-9.0%, from 33.5 million bales in 2011/12 to 30.5 million in 2012/13), India (-5.7%, from 26.5 million to 25.0 million), and Brazil (-12.1%, from 9.1 million to 8.0 million). Among major producers, only the U.S. is expected to harvest more cotton in 2012/13 (+9.2%, from 15.6 million to 17.0 million). However, U.S. acreage is expected to decrease, and the forecast increase in production is a result of expected improvement in growing conditions. Traditionally, the USDA uses recent averages for yield and abandonment when developing early production estimates. However, with extreme drought conditions still an issue in West Texas, an above average abandonment rate of 20% is assumed for 2012/13. While high relative to historic levels, this is well-below the record of 36% set in 2011/12.

USDA forecasts for demand relied on several assumptions regarding China. In 2011/12, purchases by the Chinese reserve impacted the world cotton market, and led to a record volume of Chinese imports (21.5 million bales). In addition to international purchases, the Chinese reserve program also bought a significant amount of domestically grown cotton since the price guaranteed by the Chinese government was higher than market rates around the world. For 2012/13, the Chinese government announced another increase in the guaranteed domestic price. With the global stocks-to-use ratio expected to set a new record next crop year, world prices could be expected to remain below this guaranteed level. Correspondingly, the Chinese reserve system, which enforces the price guarantee through its purchases, could be expected to buy a large proportion of the domestic crop again in 2012/13. Given that a large amount of cotton is already in reserves, the USDA expects China to restrict imports. An implication of these assumptions is that fiber prices facing Chinese mills will be higher than those in other countries. As a result, China is forecast to lose market share and Chinese mill use is expected to decrease 1.0 million bales, from 42.0 to 41.0 million. Meanwhile, every other major spinning country is expected to increase consumption. The largest increases are expected in India (+1.5 million bales), Pakistan (+1.0 million), and Bangladesh (+400,000).

All of the figures in the May report are initial projections and uncertainty remains a feature of the cotton market. Compounding questions related to pure supply and demand are those regarding government policy. In particular, decisions by the Chinese government concerning both reserve purchases and import quota could be expected to influence price direction. With a record stocks-to-use ratio, however, it should be difficult for cotton prices to increase in 2012/13.