Market Looking for Direction

November 14, 2011

Despite the dismal Texas 2011/12 cotton crop, the world crop exceeds expected use by a substantial 9.62 million bales, according to the USDA estimate released November 9, 2011. That is a 21.5% gain in world ending stocks, compared to the season before. As a result, the forecast marketing year average farm price was reduced several cents from last month's estimate to a range of 84 to 96 cents per pound for an average price of 90 cents per pound.

The surge in supply against weak demand has dropped the "A" Index world price from a record high of $2.30 per pound last March to $1.11 per pound in October 2011. Meanwhile, during the same seven months, the West Texas spot price quote by USDA for 41 grade/34 staple cotton decreased rapidly from $1.93 per pound to $0.95. The local cotton price fell about $1.00 per pound ($500 per bale) from planting time to harvest time.

A review of more recent December '11 futures shows prices moving sideways looking for direction slightly below or above $1.00 per pound.

However, the producer trying to "fix" a price at the higher level was complex, somewhat risky and fairly expensive. Because of the volatile price, premiums for option contracts were expensive - in the vicinity of 20 cents per pound. Option spreads were used such as buy an option and sell an out-of-the-money option to recover some of the costs. Traditional pricing strategies are being revised. Forward contracts are mostly based on bale contracts. Production can range from none to an above average crop on Texas dryland and irrigated acreage. Thus, growers must review their pricing alternatives in order to minimize risk and maximize income.

The futures price for the next 12 months is currently reflecting a steady to weaker market. The driving force is export shipments.

However, because foreign supply is plentiful, the export market is very competitive. Foreign production is less than three million bales short of meeting estimated foreign use. Foreign production is equal to 97.4% of use. Too, ending stocks-to-use inn exporting nations has inc rea a sed to 88% of use inn 2011/12, compared to only 54% two years earlier.

Export sales were very strong in late 2010 and early 2011 along with the sharp rise in cotton prices. But, export shipments have been sluggish since thee beginning of the 2011/2012 marketing season. Remember, sales are only an indication of potential shipments.

Most of the export sales in the first half of this year were made before the price decline in 2011. Therefore, the lower prices have triggered large cancellations of sales contracts. Foreign buyers have been unwilling too take delivery on their high priced contra acts. Many buyers are now waiting to see how low prices may go.

The strength of the U.S. market for the next several months, above or below $1.00 per pound, hinges on progress of the foreign cotton harvest and stable demand. Given that the market also reacts quickly to worldwide economic developments, trade policy changes, and weather conditions, market stability can shift suddenly to higher or lower price levels than expected.

December 2011 vs. December 2012 Cotton Futures Settlement Price


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