Cotton could trade in a range of 45 cents to 65 cents over the next few months, depending in large part on the potential for weather-related problems in the United States and China, according to an analyst.
The case for 45 cent cotton starts with USDA's forecast of a huge world crop, noted Mike Quinn, president of the Carolina Cotton Growers Cooperative, Raleigh, N.C., speaking at the Ag Market Network's September meeting.
In USDA's Sept. 10 supply and demand report, 2004 U.S. cotton production was pegged at 20.9 million bales, a 3.57 percent increase from the August report. That would leave the United States with a bearish carryover of 6.1 million bales.
Production in the world was increased to 107.25 million bales, “which is a huge world production looming over the marketplace,” Quinn said. World cotton use was increased slightly to 100.85 million bales, leaving carryover of 40 million bales, an increase of 6.61 million bales which equates to a stocks-to-use ratio of 39.69 percent.
The numbers “tell us there is a more than adequate supply of cotton for the United States and the world,” Quinn said. China's production was slightly decreased to 29.5 million bales. Imports were pegged at 6.35 million bales, use at 34.5 million bales and carryover at 7.39 million bales. “That is a stocks-to-use ratio of 21.3 percent, still relatively tight given the rate of consumption.”
Potential changes in the U.S. balance sheet depend on the impact of Hurricane Ivan and a typhoon headed toward the eastern China cotton belt.
Weather is a concern in Texas as well, according to Quinn. “Texas is the biggest cotton producer in the United States this year, but they are going to need an extended fall with a late frost for the crop to reach its full potential.”
Longer term, changes in consumption in China could impact prices, noted Quinn. Government attempts to slow China's economy and a credit crunch are signs China is experiencing growing pains.
“Over 200 million Chinese citizens are migrating from the west to greater opportunity and optimism on the eastern coast. I think we have to look at China consumption potential. At some point, China will adjust to that slowdown and will start to grow again.”
While U.S. cotton consumption is expected to remain steady, consumer debt levels, if not addressed, “will cut into consumer spending, which equates to retail sales. Since the United States is the world's per capita consumer of cotton goods, this is always on the radar.”
Meanwhile, “the U.S. economy seems to be on fairly solid footing at this time. Before the marketing year is over, we could see it soften a bit. Certainly high gas prices are cutting into disposable income.”
On the other hand, high petroleum prices are pushing up the price of synthetics, “and there are some undertones in this market that cotton may be capturing some of that market share due to our recent dip in prices.”
Another determinant of cotton price direction is spec position, noted Quinn. “In recent weeks, that position has moved from around 40 percent net short to 21.8 percent net short (Sept. 15). As a result, we've seen a rise in prices in cotton futures over the past two to three weeks.”
With about $90 billion under managed hedge funds, “the funds have the ability to push the market through the trade's idea of a proper value of cotton.”
Near term, a strengthening dollar “would not be supportive to prices,” noted Quinn. “Longer term, if the dollar does move down 10 percent to 15 percent, that would be supportive of cotton prices.”
The market has also shown the ability to move higher on bearish crop reports, which indicates an underlying strength in the market, according to Quinn.
The impact of Hurricane Ivan notwithstanding, “prices are definitely supported and probably will move higher as we are in a true weather market.
“I don't think a run toward 60-cents basis December is out of the question in the near term.
“One thing that has allowed this recent run up is simply that the crop is not in the barn and selling pressure cannot materialize until we get into harvest. Growers are balancing the market price, the marketing loan gain and a potential loss of counter-cyclical payments.”
Good planning is crucial for growers, according to Quinn. “The last thing a producer would want to do is lock in a price without any protection against a declining LDP or counter-cyclical.”
The risk a producer is trying to manage between the price and the LDP and marketing loan gain can be mitigated with options, noted Quinn.
However, “the market knows the risk, and that's why option volatility is out the roof. It's not a good time to be buying options, but if you're going to be locking down any prices, you almost have to because of the potential loss if it gains more strength.”
Longer term, more production problems from losses due to Hurricane Ivan and other storms and potential weather problems in China could push cotton toward the high end of a 45-cent to 65-cent trading range, according to Quinn.
If current USDA numbers hold true, however, “we could revisit previous lows, but the concerns about weather here and in China have taken the edge off that. We would have to have a problem with consumption to reach new lows in this market.”