The Cotton Market Through May 18, 2018
The first half of the week ending May 18 saw nearby ICE cotton futures trade mostly sideways, with new crop Dec’18 having over a cent+ rally on Tuesday. All the contracts then saw a strong uptrend over Thursday and Friday. Fundamental news this week included continued strong export shipments, decent U.S. export sales (considering the calendar), scattered rainfall events across Texas, more widespread rains in the southeastern U.S., and severe planting weather in China’s Xinjiang province. The latter apparently influenced Chinese cotton futures to rally strongly Thursday and Friday. (Note: the uptick in Chinese futures also involved shifting forward from an expiring nearby contact.) World prices were mixed this week.
Jul’18 cotton on the ICE settled higher on Friday May 18 at 86.55 cents per pound. Old crop prices remain inverted above Dec’18 which settled at 82.43 cents per pound on Friday. A sample of option prices on ICE cotton futures saw some changes from the previous week because of changes in the underlying futures. On Thursday, May 17, a slightly-out-of-the-money 80 put option on Dec’18 cotton cost 3.73 cents per pound while an out-of-the-money 73 put on Dec’18 cost 1.17 cents a pound. These values highlight the continuing opportunity to hedge minimum cash prices in the lower 70s, i.e., above projected costs of production.
This market remains supported by continued long speculative positioning and continued evidence of good demand, e.g., high U.S. export commitments and remaining potential mill fixations on Jul’18 futures. But there is some risk if the remaining hedge fund longs get spooked by some risk-off event. The April 4 Chinese tariff proposal is an example of such an event, although its effect was brief. Even after accounting for some likely upward revisions to 2017/18 U.S. exports, the longer term fundamental picture painted by USDA still implies a non-bullish picture from a moderate year-over-year increase in 2017/18 ending stocks. The same is true of the 2018/19 outlook.
Nobody ultimately knows how high these markets could go, including new crop Dec’18. The only thing you can know for sure is whether a forward contract or a hedge on today’s futures price will be a profitable, or at least survivable, price floor.
Given all these uncertainties, growers should consider taking advantage of present (or future) rallies, and protect themselves from sudden sell-offs. Forward contracting of new crop bales, immediate post-harvest contracting of old crop bales, and/or various options strategies can be used to limit downside risk while retaining upside potential. In hindsight, contracted 2017 bales could have been combined with call options on the deferred futures contracts. New crop put spread strategies to hedge the 2018 crop are a straightforward and relevant approach. Competitive bale and acre forward cash contract opportunities in West Texas have been available for months, e.g., 2.5 cents and 3.5 cents off Dec’18, respectively, for international base quality. Taking advantage of the present opportunity for selling or hedging at these levels was a main topic of conversation on the April 11 and May 11 Ag Marketing Network conference call.