2014 Outlook: China Holds All the Cotton Cards

December 9, 2013 01:37 AM
2014 Outlook: China Holds All the Cotton Cards

Editor's note: This is one of seven 2014 marketing outlooks that the AgWeb editors are providing to help you succeed and be profitable in the coming year. Please check back each Monday for another outlook.


What China decides to do with its massive reserves, and whether Chinese growers pick up production, will determine the direction of cotton prices in 2014.

Cotton prices tumbled 14% this fall after the Chinese government announced that it intended to start selling cotton from its 10-million-ton stockpile. But prices stabilized around 75 cents after the state-owned China National Cotton Reserves Corp. managed to sell only about half of what it offered—most of it cotton from the 2011 growing season.

Cotton producers could be in for another wild ride in 2014 as the Chinese government continues to sell down its stockpile. It also plans to announce new policies in the spring for the 2014/2015 growing season. Because China accounts for nearly half of U.S. cotton exports, its decisions will have a major influence on the fortunes of U.S. producers in 2014.

"The big story of 2013 is that the quality of the stuff (China) put up for sale isn’t that good," says Jon Devine, a senior economist for Cotton Incorporated. Fewer than a quarter of the domestic textile mills present for the Nov. 28 sale bought lots. Many of the rest continued to buy U.S. cotton on the open market, despite having to pay a 40% duty.

The Reserves Corp. asked for $1.33/lb. for cotton from its reserves, nearly twice the price of the futures market, according to the International Cotton Advisory Committee (ICAC).

Concern over how much and what kind of cotton would sell injected "tremendous uncertainty" in the market during the fall, says O.A. Cleveland, an agricultural economist at Mississippi State University. Now that the Chinese have declared their intentions, Cleveland expects prices to return to the 80- to 90-cent range, with the usual rallies early in the year and during planting season. He thinks the Chinese government will refrain from dumping its reserves on the market for fear of undercutting the value of its reserve and hurting its domestic producers.

"As farmers have opportunities to move cotton above 80 cents, they should do that," says Cleveland, adding that the typical cotton producer needs about 75 cents per pound to break even. "But I’m looking to 84 before doing anything, given the current situation. I’m thinking that 90 or 95 cents may be the top end."

More Unknowns Loom on the Horizon

Cleveland is much more bullish about prospects for 2014 crop prices than Devine, who expects the market to go sideways until spring. That’s when China will announce its reforms for the 2014-15 growing season. The rumor, Devine says, is that the Chinese will move away from making stockpile purchases and toward making direct payments to farmers. "But it’s not clear who will be eligible," he says.

That’s just one of several unknowns likely to roil the market in 2014. If demand from the Chinese government for reserves declines, which it did during 2013, that will continue to exert downward pressure on world prices. But if Chinese domestic producers step up cotton purchases from the U.S., China’s largest supplier, that could help prop up prices. And if more Chinese acres go back into cotton production, that could theoretically lower world prices.

John Robinson, an agricultural economist at Texas A.M. University, believes the downside risk of sell-offs from the Chinese stockpile is bigger than the upside opportunity of more demand. The Chinese government decision to sell from the stockpile, he says, has effectively "capped the upside," leaving open the possibility of lower prices, especially if speculative funds downshift out of their new long positions or China curtails imports to liquidate its stockpiles.

Robinson suggests that farmers take out options for downside protection on their 2014 crop. He says growers should consider buying "near-the-money" put options and at the same time selling a "deep out-of-the money option" as a way to buffer a decline from revenue insurance policies.

"As a matter of fact, put options on December 2014 cotton are relatively inexpensive considering how early it is," he says. "Last Friday, a grower could have bought a 77 put and sold a 70 put for about 3 cents net premium cost. This would act as insurance against a futures price decline down to about 70 cents."

Taking such a position, Robinson says, would buffer a grower this winter against the possibility of a price decline during the important insurance price discovery period. Though it varies by region, it typically involves an average of a month’s worth of December 2014 settlement prices during the winter.

Robinson expects cotton prices to rally after such a big decline in October and November. "But I consider any rally as an opportunity to put on more affordable put option strategies against the uncertain future of Chinese stockpiling policy and world supply and demand outcomes," he says.

Projecting the 2014 Crop

In the meantime, prices will be strengthened by a decline in U.S. cotton production this year. USDA currently pegs the cotton crop at 13.1 million 480-pound bales, down 24% from last year but still higher than 2008 and 2009 levels. Some farmers, tempted by high prices paid for corn, decided to plant corn instead of cotton this year. Too little rain in Texas, the top cotton-growing state, also negatively affected production.

"The 2014 U.S. crop will be a little smaller," predicts Cleveland. "But the high yields that we are getting are here to stay. The seed companies are giving us tremendous genetics."

The ICAC projects that world cotton production will outpace consumption by roughly 2 million tons during the 2013/2014 season. It also estimates that supply and demand will come back into alignment during the 2014/2015 season, which would bolster prices. Here are the organization’s projections:

  2013/14 2014/15
Production 25.64 24.82
Consumption 23.77 24.55
Ending Stocks 20.32 20.59
Projections in millions of tons

Source: International Cotton Advisory Committee



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