Unpredictability Causing Price Peaks, Valleys
September 14, 2009 International market forces are changing the U.S. cotton marketing system. Export demand is driven by both foreign trade policies and supply. At the same time, the market is responding to an economic mix of developments at home that are not directly tied to the cotton industry. These developments include strength of the U.S. dollar, business conditions, retail demand, stock market, grain prices, and speculators.
The combination of unpredictable market-making forces can cause sudden and sharp movements in cotton prices. The market can move faster and further than expected in either direction. Too, the difference in cash and futures prices (basis) is more volatile than in the past. For the futures price to be used effectively in price risk management, the cash and futures prices must converge, except for delivery costs. Thus, the ability to deliver cotton on the futures contract becomes essential.
The December ’09 futures price in August 2008 was around 80 cents per pound. The price started to drop in September 2008, to below 50 cents by December ’08. There has been little chance to price 2009 cotton above 65 cents for almost a year. A basic price hedge could have been placed to sell December ’09 futures before or in August 2008. But, the threat of large margin calls, should the market move up, provided a substantial financial risk until the contract was bought back or qualified cotton delivered.
Most of the time delivery by a grower is not convenient. The use of options more than a year ahead of harvest is associated with a large premium due to time value. However, the 80-cent price as of August 2008 would be a big boost to cash flow this harvest season.
There are numerous trade-offs in developing longer-term pricing alternatives. Most pricing strategies will require some modifications to managing price risk for more than a season.
As marketing programs extend price protection, specialized price risk management expertise and a strong financial backing will be required.
The main marketing objective will be to establish a desirable price level with the flexibility of benefiting from favorable price moves far in advance of a year ahead. Also, the electronic selling and buying of cotton from all parts of the world provides a cost-effective central marketplace.
Add graph & photo
GET THE NEWSLETTER TODAY!
