Cotton Supply Remains Scarce

December 10, 2010

The latest USDA 2010/11 cotton estimates decreased U.S. ending stocks to only 1.9 million bales. However, foreign stocks were raised, leaving a small 1.2 million bale increase in world stocks. Thus, world ending stocks remain at about the same level as a year ago.

The estimated U.S. cotton crop was lowered a little from 18.42 million bales to 18.27million. Production was decreased mostly because the Texas crop was lowered to 8.05 million bales from 8.3 million last month. Too wet conditions followed by too dry conditions sharply reduced the West Texas dryland crop yields.

U.S. domestic mill use was raised 100,000 bales to 3.55 million bales and exports 15.75 million were unchanged despite lagging export shipments versus sales. The farm price received for the 2010/11 crop was forecast at 76 to 86 cents per pound.

World production was raised slightly to 115.53 million, and consumption reduced marginally to 116.25 million bales, compared to 118.4 million last season. But, total consumption is well above the 109.95 million in 2008/09 and well below the 123.33 million used in 2007/08.

The December ’10 futures price followed a rollercoaster pattern since moving above 80 cents per pound last August on its way to over $1.50 per pound in November. But, then it dropped to $1.13 in 10 days and recovered on last trading day at $1.38. December ’11 futures lagged far behind in going from 75 cents to almost $1.00 per pound. But, December ’11 dropped only to 84 cents and has recovered to 94.51 cents per pound by December 10th.

At this time, December ’11 futures reflects the expectation of increasing cotton stocks somewhat in the next year. Yet, stocks will be tight. World production is expected to increase, while demand may stay stable at best. Also, the use of man-made fibers has increased because of high price for cotton.

However, competition for acreage next season is expected to be intense, especially from soybeans, corn, grain sorghum, and wheat. Therefore, a strong cotton price will be needed to increase cotton acreage beyond 11.0 million next planting season in the U.S.

The market early next year will be very sensitive to potential adverse weather conditions. Most of the U.S. “Cotton Belt” is suffering from moderate to extreme drought conditions this fall. Already, adequate subsoil moisture is getting questionable. In Texas, over 3 million dryland acres in the cotton regions are short to very short of moisture.

Without above average rainfall the next three months, the Texas cotton crop may be several million bales less than this year’s 8.05 million bale harvest. Assuming a 10 percent increase in U.S. cotton acreage and above average abandonment, the 2011/12 crop could be in the 18.5 to 19.5 million bale range, essentially the same size as this season.

Given uncertain acreage and yield, December ’11 futures will likely remain trading in the ninety cent to slightly above a dollar per pound level. Growers need to consider the risk and rewards of forward contracting, placing cotton in a marketing pool, using options with a forward contract, or fixing a price floor with options and option spreads. Also, evaluate using several different pricing strategies.

In the past, when futures price ran away from cash price for a while, the chase stops and futures price drops sharply. The amount of price decline could be similar to the 20 to 30 cent recent run-up of price.

The bullish surge in futures price is supported by many traders that do not use cotton. Yet, the mathematical models driving electronic trading can turn bearish faster than they turned bullish.

Therefore, producers and other owners and textile manufacturers must rely on a strong price risk management program to maintain financial obligations. Because many market forces are not visible, hedging programs need to consider hedging futures positions with options to protect extreme margin calls. For example, short futures positions can be protected with purchase of calls at various strike prices at or out-of-the-money.

Given the combination of current extreme non-user market positions, producers of cotton need to consider fixing price or selling this season’s cotton soon and fixing a price on next year’s crop of 2011/12 cotton. Out-of-themoney put options on December 11th are viable.

Best wishes for a Happy Holiday Season and a Prosperous New Year!


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