With a record carryover from a record 2011 world cotton crop, the slide in prices could’ve been even steeper, says Hank Reichle, were it not for the 20 million bales of reserves being held off the market by the Chinese government.
“All that cotton is just sitting in their warehouses, and it’s only going to be available when they say it’s available,” he said at the joint annual meeting of the Southern Cotton Ginners Association and the Delta Council Ginning and Cotton Quality Committee. Reichle is vice president of export sales and market administration for Staple Cotton Cooperative Association at Greenwood, Miss.
“To the Chinese government, that 20 million bales is minuscule in the overall scheme of things,” he says.
“If we subtract those bales out of the market, it gives us a stocks–to-use ratio below 50 percent. That’s why cotton prices today are at 70-odd cents rather than 50 cents, like they would’ve been if all that cotton was sitting in the market looking for a home. And we’d probably be getting out of cotton pretty quickly if we were looking at 50-cent cotton versus $13-plus soybeans.
“It’s a positive factor for the cotton market,” Reichle says, “that the Chinese government has absorbed some of the world’s cotton excess in their reserve. When they start to release that cotton, they’re far more likely to be price limiters than price suppressors. They’re not under pressure to dump their cotton — they can sit there and hold it as long as they want to.
“They paid $1.20 for that cotton, and what’s most likely to happen is, as prices rise, they’ll ease it out into the marketplace. They’re inclined to hold cotton, because they didn’t have enough in reserve when prices spiked in 2010.
“They want to control prices, and those reserves will act as a limiter on prices and help keep them at a level where you can grow cotton profitably. I don’t see it in the cards for them to one day just dump all this cotton on the market.”
While the world is sitting on a lot of unused cotton from 2011— some 67 million bales estimated by the USDA for the marketing year ending July 31 — the situation isn’t as gloomy as the numbers might appear, Reichle says.
“Looking at the stocks-to-use ratio, that carryover means that 63 percent of the cotton that’s going to be used in a year is represented in these stocks.”
A number above 50 percent is bearish, he says, while the upper 40 percent range tends to be neutral, and a number in the low 40 percent range “is when we start to see a situation where stocks are really tight.
“Right now, on the surface, the world cotton balance sheet is as bearish as it has ever been, especially in terms of total bales and the stocks-to-use ratio.
“But, the U.S. is tight with a 22 percent stocks-to-use ratio. India’s ratio is also tight.. China is the biggie with 27.33 million bales ending stocks. They’ve brought in cotton from their own producers and from the world market for their state-owned reserves, which they’ll hold until they’re ready to release it.
Neutral to slightly bullish
“So, if we look at the rest of the world, excluding China, the stocks-to-use ratio is in the range that’s sort of neutral to slightly bullish. While there’s a lot of unused cotton in the world, a lot of it is being held off the market.”
Unfortunately, Reichle says, 2012 numbers don’t look any better.
“We’re actually going to reduce world production by about 9 million bales through fewer acres planted, which indicates growers are responding to lower cotton prices and higher grain prices by growing less cotton.”
At the same time there’s record carryover, Reichle points out, “growth in demand is very slow — it’s projected to increase by only about 2.2 percent next year.
“The net result is that world stocks are projected to climb again next year and the stocks-to-use ratio will still be high at 66 percent. So, the job of the futures market is to keep cotton relatively cheap, make man-made fibers more expensive, and at the same time, get rid of excess acres in the world.”
And the job of the grains futures market, he says, is to “stress demand and increase supply, because there is such a shortage, especially in view of the South American weather earlier this year that limited their production, and now the drought in the U.S. Midwest.”
Looking at the last 12 years of world cotton production/consumption, “what we’ve been through in the last three years is absolutely remarkable,” Reichle says. “Prior to that, cotton prices were not going up in concert with grain prices. Finally, about in 2009, cotton production had to go up because we had one year in which we consumed 16 million bales more than we grew.
“Unfortunately, that led to $1 and $2 cotton, which most producers didn’t get to take advantage of. But that led to a big change in production and a drop in consumption, and we produced 16 million bales more than we used.
“That kind of volatility is never good,” Reichle says, because of its adverse impact on consumption.
“When cotton prices went above $1, things were still OK from a consumption perspective, but when we started getting into $2 cotton and we started seeing 20-cent and 30-cent price moves in a day — more than we used to see in a year — textile mills around the world started making their products with something other than cotton.”
The 2011 Supply and Demand reports showed a steady decline in the use of cotton — an 11 percent drop in demand during an 18-month period, Reichle says.
“In 2002, cotton accounted for 38.7 percent of all fibers used in the world. In 2011, that had dropped to 31 percent.
During 2009, 2010, and 2011, the world was using more fiber, but cotton’s share was not only dropping, actual cotton consumption was going down — and that decline was in response to much higher cotton prices than the historical average.”
During the period when ethanol production was driving up corn prices, and ultimately soybeans, producers around the world cut their cotton acreage in favor of those crops, Reichle says.
“When supplies cotton supplies began to get tight and prices went to 80 cents, 90 cents, $1, and $1.50, producers began planting more cotton. When the price dropped below $1 this year, cotton plantings went down.”
Supply, demand shocks
Looking at cotton prices over the last 40 years, Reichle notes, the average price was 66.61 cents.
“But the price moves the industry has had to deal with the last couple of years have been off the charts. So, it’s not surprising that we’ve seen a shock in both supply and demand. Hopefully, those days are behind us and we’ll have a more normal market going forward, which should help consumption to move back up.”
For 2013, Reichle says, “The grains and oilseeds markets will need every acre they can get, first from the southern hemisphere, then from the northern hemisphere. If we look at the futures market, they’re trying to buy as many acres as they can from anywhere in the world. This means cotton acreage is going to drop around the world and in the U.S.”
Cotton will still be grown where there is little ability to switch crops, or for infrastructure reasons, or for rotation reasons, he says, but for 2013, “We kinda suspect Mid-South acreage will drop back to the 2009-2010 level.
“We don’t know how quickly the grain markets are going to ration acreage. We feel like cotton is going to go down to historic lows, but we also expect big acreage cuts in cotton around the world in 2013.
“At some point, probably in 2014, the cotton market will have to come back into the acreage battle and take back some of the acreage it has shed over the last couple of years.
“Last year, when growers around the world were making planting decisions for 2012, cotton was 90 cents to $1 a pound and grain prices were 30 percent to 40 percent lower than they are now — yet cotton acreage was still sharply reduced around the world.
“Next year, if we’re looking at 70-cent to 80-cent cotton, or maybe a little lower, and grain prices stay strong, there will be cutbacks in cotton everywhere in the world. And that’s what we need to be able to get supply-demand back into kilter, so cotton will join the acreage battle again and prices will rise to give you an incentive to plant.
Things to watch over the next 18-24 months, Reichle says:
• The Chinese reserve policy. “Will they continue to buy and hold or will they release some of that cotton? This will have a huge bearing on the market.”
• Potential world crop problems or high yields. “We know acreage cotton dropped this year, but we don’t know if we’re going to have weather disasters or bumper crops. Obviously, the more weather disasters we have, the more friendly it would be to the market, or vice-versa.”
• How the world responds in 2013 to the grains/oilseeds shortage. “Hopefully, growers will switch to what’s most profitable; if that’s the case, cotton will be able to join the game much sooner in terms of getting acres back because they’re needed.”
• A resurgence in cotton consumption. “We’re continuing to see lackluster demand. A lot of that is due to the damage that $2 cotton did, a weak economy, what’s going on in Europe, and other concerns. There is a lot of fiber chasing a small market. As demand returns, and we work out problems over the longer term, that should lead to better cotton consumption.”