Additional import quotas from China and a supply disruption somewhere in the world could push cotton prices higher in the short-term, according to analysts at the recent Cotton Roundtable in New York City. In the long-term, a price correction could come when the market recognizes that the world is consuming more cotton than it produces.
When these factors might converge proved a much more elusive question for the analysts, speaking at the annual mid-season discussion of the cotton market's psychological, fundamental and technical makeup.
The roundtable event is sponsored by the New York Board of Trade, Certified FiberMax, Cotton Incorporated, Ag Market Network and Farm Press Publications.
In the short-term, cotton's outlook is neutral to bearish, according to Joe Nicosia, president and CEO of Allenberg Cotton Co., in Memphis.
“We have adequate supplies around the world. World growers have been encouraged by huge yields. Even though prices have been only average, their returns have been very good. In Pakistan and India, yields are finally starting to increase, up 25 percent and 50 percent, respectively. They have very large planted acreage. It's not a one-time event. They have better technology, better seeds and better practices.”
The problem with China is that it's not in the market for cotton right now, Nicosia said. “China buys roughly half of the bales around the world, so obviously we need them in the marketplace to support prices. And that's one thing that has really been missing in the last 30 to 45 days.
“Normally, when there is a 2-cent pullback in the market, demand would surface. But we're not seeing that now. Luckily, we're not in the middle of a harvest season, where we're seeing a lot of hedge pressure on the other side. But the demand is not strong enough to support prices.”
Long-term, the view is bullish, according to Nicosia. “We've never seen anything like this increase in consumption. The two most populous countries in the world, India and China, are having dramatic changes take place within them. Their economies are starting to grow, they're really moving a large section of the population from a farm-based community to a middle-class and middle-upper class lifestyle. So their cotton demand continues to grow.”
Mike Stevens with Swiss Financial Services, added that China “is the fourth or fifth largest economy in the world, yet on a per capita basis, they're more than 100 down the line. So the greatest growth is coming internally in China. It's not so much them spinning goods and sending them back here. It's them furnishing goods for their own people.”
The biofuel industry could also have an impact on cotton prices, according to Nicosia. “Any commodity related to energy conversion will have its prices soar. By cause and effect, in 2007, these prices are going to start to pull acreage away from cotton in other countries. So at the same time that consumption is starting to create record demand for cotton, we will have acreage pulled away for biodiesel and ethanol.”
Nicosia says that deferred cotton prices “are going to have a very hard time holding on to acreage. Yet at the same time, we're going to have a heavyweight pulling on the front end — a 50 million-bale stock number for the world.
“So as we have deferred prices trying to rally and front end prices with too much supply, the marketplace will try to solve that by putting in very wide carries in the marketplace. We've seen that over the last few expirations, where the futures months have expired at very wide levels. I think that is going to continue into next year.
“In 2006, the marketplace is probably going to tread water with adequate supplies. We can see a tightening coming, but it's not here yet. In 2007-08, if yields and acreage don't keep rising, prices will. So the excitement is coming, but it's just one year away.”
Nicosia believes prices will rally “when we have verification of the longer-term gap between supply and demand. When we look at 2006-07, we have a very wide gap between production and consumption. Eventually, it's going to get wider and wider. When we get confirmation that this exists, the price will move up. That has already happened with corn and sugar. The marketplace won't wait until the spot demand is there. It will do it when it sees the future.”
According to O.A. Cleveland, professor emeritus, Mississippi State University, part of the reason for the projected decline in U.S. cotton exports in the coming year “is that we have so much cotton in storage that we've sent to China on consignment. It's going to take a while to work that cotton off the market.”
Cleveland doesn't see a price impact from the loss of Step 2 payments. “Empirical evidence out of Texas seems to suggest that Step 2 accounted for only about 125,000 bales in exports annually. Primary industry groups will tell you that Step 2 gave us only 50,000 bales to 60,000 bales domestically. So it's less than 200,000 bales.
“Some people say the market will lose 3 to 5 cents because that's what the Step 2 payment was. But the market didn't go up 3 to 4 cents when we started Step 2. What Step 2 did was lower the world price of cotton. Take Step 2 out and we'll see a higher world price of cotton.”
The loss of Step 2 “may make it tougher for producers to get their equity,” added Stevens. “The buyers don't have that fudge factor anymore.”
Prices could take a turn for the better with a significant decline in ending stocks, according to Carl Anderson, Extension specialist emeritus, Texas A&M University. “Demand is very strong. We're still very early in this crop season, and the crop could turn out better or a lot worse.
“What would raise prices would be a decrease in world stocks of more than 4 million bales. USDA has projected a decline of 7 million bales and if that turned out to be the real fundamental a year from now, I think we would see a rise in prices considerably above where they are now.
“We have a lot of questions on the supply side of this year's crop,” Anderson said. “Futures are going to be working that out and the Chinese crop is (still uncertain). When we look at the current fundamentals, we could see a strong rally coming in around September, given that stocks could be tighter than they are now. Remember, markets will either go too high or too low. If we ever break that 59-cent, 60-cent level, I think we're at 62 cents.”
According to Jarral Neeper, vice president of marketing, Calcot, Ltd., “Without some sort of surprise, it's difficult to get too excited about prices, one way or another. If you look at the past 24 months, the market has had good support between 42 cents and 46 cents and very good resistance between 56 cents and 60 cents. We have spent a heck of a lot of time between 48 cents and 56 cents.”
“You look at any market over a period of time, you can take off the top 10 percent and the bottom 10 percent,” said Stevens. “I think December cotton at about 62 cents is a very good possibility.”
“I'd rather be long than short, only because the risk/reward is very much skewed in this marketplace,” Nicosia said. “If everything is normal, it's headed to 48 cents to 50 cents. However, with hurricane season ahead of us, if we have confirmation of large abandoned acreage in west Texas and get import quota into China at the same time they are having trouble with their crop, we could easily see 65 cents to 68 cents. I don't think it's going to happen, but you have to respect that possibility.
“However, there is a better than 50 percent proposition that December is going to end up lower than it is today. There is also a 25 percent chance of a 15-cent rally. I see a downside of 48 cents to 50 cents and an upside of 57 cents to 58 cents.”