For the short term, cotton producers will likely not have to worry about a large dip in prices because of the Chinese dumping inventory of cotton, but should be more cautious about this and other looming hurdles for cotton prices next spring, says Kelli Merritt, cotton producer, broker and merchant from west Texas, speaking at the Ag Market Network’s September conference call.

Merritt said the Chinese plan to ditch their stockpiling scheme in favor of subsidies to farmers is part of a calculated plan. “I will continue to believe that the Chinese don’t just fall into these awkward situations. They plan in advance how they’re going to do it, and then methodically act out their plan. They appear haphazard, but I really don’t believe they are.

“They protect their farmers because they really can’t afford to enact policies that encourage more rioting in Xinjiang and other areas. They protect their spinning industry for the same reason.”

Merritt says one option for moving from stockpiling to subsidizing is the use of a target price similar to one used in the Unites States that supplements a farmer’s income if the market drops below a reference price.

“One problem with a subsidy program in China is that Chinese farmers are small and isolated, and making a subsidy payment to each and every farmer in an equitable fashion can be very difficult,” Merritt said. “In other words, they don’t have a well-oiled machine like the Farm Service Agency to keep it all straight.

The Chinese could stop the stockpiling program by lowering auction prices, which could make domestic cotton cheaper than imported U.S. cotton, Merritt said, “even when done outside the quota system with additional tariffs added. So there are a lot of questions on how they are going to implement the plan.”

Merritt said China’s Ministry of Finance wants to discontinue the program partly because they are tired of paying out the money (around $33 billion), and partly to protect the textile industry. “It’s one of the many moves the government is making to reduce expenditures, reduce loans and aid economic growth. By allowing the reserve auctions to be offered at lower prices would help spinners buy U.S. and other growths at closer to world prices than where they are now.

“The Chinese “always have to walk a delicate tightrope between supporting farmers so much that they hurt the spinners and vice versa. And they have millions of workers to think about.”

Merritt added that the Chinese don’t have to start dumping cotton to drive prices down. “All they have to do is stop buying cotton.”

Merritt says the world should know the specifics of the new policy within a few months. “But some say there won’t be an announcement, that they will suddenly issue some more quotas to mills,” Merritt says.

“All this is setting up an environment for the Chinese spinning industry to continue moving to other Pacific Rim countries, like Pakistan, India, Vietnam and Indonesia. Pakistan has even referred to this situation as a once in a lifetime opportunity, although it may be limited by their lack of energy access to increase their spinning industry (capacity).”

Will continue to import cotton

Merritt believes that China will continue to import more and more yarn from other countries. “Some estimate they will import as much as 8 million bale equivalents of yarn in 2013.”

Possibly bullish news from India is whether or not they will impose a 10 percent tax on cotton exports, according to Merritt. “Word is that we should hear any day on that. If they did, it could really help prices.”

Meanwhile, the cotton market seems to have found demand at around the 82-cent level, according to Merritt.

“This level just seems like a sweet spot for the market. We saw really strong export numbers yesterday (Sept. 12) at 134,400 bales sold to 16 countries, along with 16,000 bales of Pima. Total sales and shipments so far this marketing year are just over 4 million bales. This is saying that mills don’t mind locking in their prices at these levels.”

Merritt said any announcement from China that would make reserve cotton more affordable for its domestic mills “could send us lower. How much is anybody’s guess.”

Cotton producers should keep an eye on December 2013 futures, Merritt said. “The small inventory of high grade cotton and the possibility of lower grades overall in this year’s crop could cause December to go higher, depending on how the mills view the situation as the crop is harvested. Right now, the mills in China are in a bit of a wait and see mode.”

Merritt says a breakout of cotton prices to over 85 cents “would definitely see fund-buying coming in.”

Merritt doesn’t see a big downside for December 2013, with less than two months left until expiration, “but you never know. A sound business practice is to always lock in profitable prices if they are available.”

For 2014, Merritt advises producers to consider locking in some cotton in the spring, at planting or before. “It could be one of those years where what you’re looking at in the spring is not what you’re looking at later in the year.”

Carl Anderson, Extension professor emeritus, Texas A&M University is more concerned than ever about downside risk in the cotton market, especially with changing Chinese policy and the possibility of fund involvement.

“You need to be watching a number of variables in the cotton market. Don’t take a lot of risk that the market is going higher. When you put it all together, the downside risk over the next several months is much greater than the upside potential,” Anderson said.

USDA’s September supply and demand report, which put world production at 117 million bales and consumption at 109 million bales, suggests that there is plenty of cotton in the world. India, with 6 million bales of exportable cotton is also expected to be a major player in the market.

“In this market, we have to learn how to use put options and call option spreads to reduce the cost of holding cotton. Don’t hold cash cotton thinking it’s going to go up faster than the cost of storage. “

Anderson noted that U.S. exports could weaken because of equilibrium between foreign production and consumption. “We’re in a market that is highly risky. Protect the downside and don’t worry too much about the price going up.”