The new year has brought new optimism to the cotton market — with three top cotton market analysts saying December 2009 cotton futures could easily approach or top a dollar a pound.
“I don't think we've had markets this wild since 1995, and we're in an environment where it could be with us for several years,” said Mike Stevens, Swiss Financial Services, Mandeville, La., during the Ag Market Network's January teleconference.
Most agree that the impetus for optimism has a lot to do with grain prices. O.A. Cleveland, professor emeritus, Mississippi State University, said in order to maintain a soybean-to-cotton price ratio of 10 to 1 (the estimated breakeven price ratio between the two competing crops), at soybean prices of around $13 a bushel, “cotton has to be at least $1.10 to $1.15 or maybe even higher.”
These prices are expected to be seen in December 2009 cotton futures. In the short-term, Cleveland believes December 2008 “will focus on about 85 cents on the upside with a low of 74 to 75 cents.”
Like Stevens, Cleveland believes high cotton prices might be more than a passing fad. “This one could be a two- to four-year price blip, and we're going to see some high cotton and grain prices for several more years. We have some very exciting times ahead of us in cotton trading. Cotton, in fact, is catching up now in big fashion with the outside markets.”
Carl Anderson, professor Extension specialist emeritus, Texas A&M University, says the fundamentals of the market “are looking more and more supportive. The big news from the latest crop report was that foreign stocks fell 740,000 bales while U.S. supplies increased 200,000 bales. This means we have plenty of cotton around the United States.”
In more good news, China's cotton stocks were lowered 1.5 million bales, and Chinese production from 2007 was lowered 1 million bales.
Anderson pegs U.S. cotton acreage at 9.4 million acres for 2008, down sharply from 10.8 million acres in 2007, and significantly down from 15 million acres two years ago. “So stocks are going to be tighter than they've been in a long time, and if the market starts to get excited about that, we should see some real good runs ups. Producers should keep an eye on this market, to see if there is an opportunity to take advantage of the high prices.
“We're suggesting in the short run, look for selling opportunities at 70 cents or above in the nearby futures if you still have any of last year's crop. For December 2008, the good news is that grains have bought a lot of cotton acreage and will continue to buy cotton acreage if the cotton market does not get up over 80 cents and show good strength heading for 85 cents.”
Strategies run from the simple to the complex. “The simplest thing you can do is buy an out-of-the-money put. At 85-cent futures, look at a put option in the 76- to 78-cent range. That's a pretty good floor. The 10-year average for the December high is 71 cents. So we're well above anything we've had in recent times. But it rarely stays there long after it gets there.
“Some other strategies are a little more complicated, like bull-call spreads that we're going to have to learn how to use and implement.”
Anderson sees 2008 crop prices moving into the middle 80s. Longer term, “I think it's easy for 2009 to get to 95-cents to a dollar, and I am leaning more and more toward December 2009 going well above a dollar. At the 10 to 1 soybean-to-cotton price ratio, that means $1.10 to $1.20 for cotton if it stays in that relationship with soybeans.”
Technicals also support a strong upside for the cotton market, according to Stevens. He noted that on Jan. 15, speculative longs moved to an all-time record position. “Speculators have added 20,742 new longs just since the first of the year and 40,367 new longs in the last five weeks since futures bottomed at 63 cents.
“Specs were net long the equivalent of 7.111 million bales. On the other side, the short hedges went up to a new all-time, short position equal to a little over 19 million bales. So basically, the entire crop now is short this market. You have some dynamics that are really going to feed the volatility.”
Things didn't look as positive a few days earlier. “On Thursday, Jan. 10, prices were on the verge of a move to the downside. Many traders were shocked to discover that asset rebalancing by the index funds did not mean that cotton futures would necessarily be bought. In fact, several of the funds were giving less weight to cotton rather than more.
“This resulted in a quick 3-cent retracement. We went from just below 70 cents to just under 67 cents, with heavy hedge selling in both futures and options. The market looked like it was going to test the fundamental demand at 66 cents. Instead, prices moved limit up the next day, and opened the door to a second, limit up move the following Monday. By then prices had rallied to 73.7 synthetically.”
Stevens believes that 90 percent of the 6-cent rally from Thursday's low to Monday's high “was on the huge influx of investment capital that was simply following the grain explosion.”
Meanwhile, the export business for cotton “has been virtually non-existent. The dip below 67 cents on Jan. 10, however, uncovered some demand, something we'll know when the next export figures are released.”
With as much as 90 percent of the movement in the cotton market due to higher prices in the grain market, Stevens stresses, “trees don't grow to the sky, and markets are going to have to take some time to rest. There's a real good chance that if the grains take a rest, cotton will too. If that is the case, we'll probably move into a trading range, with underlying demand in cotton preventing any kind of a washout.
“We are in an environment where open interest is going to continue to grow over the next few years and so will volatility. The market is already anticipating cotton in the 80s or 90s, and believe it or not, we already have a fair number of dollar bulls out there. So this is a time to be ready to take advantage of moves. The marketing opportunities are probably going to be the best we've seen in 10 to 15 years.”