Shrinking LDP, falling prices hurt producers in 1999-2000 There is something to take home from the often-puzzling movement of the cotton market this past year - there is no marketing tool designed to offset the adverse impact on the LDP when world prices rise and New York futures prices fall.
This situation created an "unmanageable price risk" in 1999-2000, said Mark Lange, director of economic services for the National Cotton Council, during an address to attendees of the 2001 Beltwide Cotton Conferences in Anaheim.
The economist noted that in January 2000, the nearby New York Cotton Exchange No. 2 contract traded at an average of 51.9 cents per pound and the A Index, an indicator of world price, averaged 44.3 cents. Subtracting 14 cents from the A results in an adjusted world price of 30.3 cents. The LDP (the loan rate minus adjusted world price) was 21.9 cents per pound.
However, the first week of January 2001found the nearby NYCE No. 2 contract trading at 60.1 cents per pound and the A Index averaging 65 cents. The LDP was virtually eliminated (0.42 cent).
In effect, the A Index rose over 20 cents per pound during the course of the year while the nearby NYCE contract rose only 8.2 cents per pound. Basis to growers, as estimated by USDA-AMS, appears to be largely unchanged from a year ago.
During most years, if movement in the U.S. domestic price matches the A Index movement exactly, "then the producer is trading off reduced LDP value for a higher market price, assuming basis remains unchanged," Lange explained. "In this case, the price movements leave the producer receiving a total cash value for the cotton that is constant over a range of values for the A Index.
"However, if the U.S. domestic market fails to rise penny for penny with international prices as measured by the A Index, then the LDP falls faster than the increase in U.S. cash prices for cotton. This situation results in a decline in total cash value of cotton to the producer despite a general increase in market prices."
Lange explained that the world price went up quickly once the world was able to figure out a number of uncertainties about China's crop and trade status. But a fairly stable supply-demand situation in the United States meant that U.S. prices went up much more slowly, thus the gap between U.S. and world prices.
Lange said it would be difficult to justify adding an exchange-traded instrument that provides a measure of protection for growers facing the shrinking LDP/falling domestic price situation. "Liquidity would be an issue and most importantly, what volume could be there if the A Index were generally trading the 70-cent range? The instrument might not trade."
Looking ahead, Lange added that if the A Index remains in the mid-60s or moves higher, then some increase in foreign cotton production should be expected in 2001. "Weather will play its usual role in affecting the actual crop size.
"A reasonable expectation might be that any increase in foreign crop size will likely be matched by a corresponding increase in foreign mill demand. In all likelihood, the United States will have larger exportable supplies than 7.6 million bales. Failing shipments of larger exports, the United States could build stocks during 2001."
Until a recent announcement by the National Statistical Bureau of China of a 20-million-bale crop for 2000, there were widespread expectations of U.S. and foreign cotton sales to China during the spring of 2001.
What is China's plan for 2001? Lange says China could draw down its own stocks further, put additional support into procurement prices, make further changes in the players allowed to participate in cotton buying and selling, provide for import licensing and formally join WTO. "The latter would require China to open an import tariff rate quota of over 3 million bales with only modest duties applicable."