Spinners Should Sell Yarn before They Buy Cotton
February 22, 2012 To illustrate the challenges spinners face during these volatile times, please assume that you have a medium-sized yarn production plant operating with an average of 4,000 tons of raw materials, and finished stocks as working capital. The question is: How do you successfully operate this business during economic instability?
Reality-Based Pricing
The impact of temporary caution due to the global economic crisis in 2008 has slowly disappeared. Now the world faces a new crisis. We are passing through a period in which even nations with strong economies are worried. The basic economic rules do not apply because the intersection point of supply and demand does not determine the price. Expectations, rather than the values of real production and consumption, determine the price.
In recent years, papers – rather than actual commodities – have been traded physically. Brokers who have not seen any real cotton are the ones who determine the price.
When cotton prices from the last two years are taken into consideration, the value of a firm that has 4,000 tons of stock fluctuated between $6 million and $18 million. Within this period, when cotton prices fell through the floor, producers were obliged to sell at a price below their production cost. When cotton prices reached their peak, yarn producers had to sell at a loss because of high input costs. As a result, some cotton producers shifted production to other crops and yarn producers closed their plants. Few were able to escape some type of financial problem.
In the coming period, a global economic crisis and a recession in the world economy are more likely. This discontent brings about significant declines in cotton prices.
In the short run, my expectations are that there will be no more price increases, but I don’t think that the price will drop below 75 cents/lb.
With that in mind, how should we manage our firms?
• Use available information. We are living in the information age. On one hand, we closely follow the world economy and our sector; on the other hand, we should carefully analyze our own operations.
• Producers and consumers of cotton should establish closer relationships with each other. Cotton prices should be based on actual demand and supply rather than derivative markets.
• Cotton growers should increase their productivity and quality by further refining modern agricultural techniques. Yarn firms should enhance their efficiency and effectiveness.
• Firms should have adequate stocks to sustain operational capital, and avoid the risk of having less or more stock than they need by carefully forecasting future demand.
• Yarn producers should sell, and then buy. In other words, they should quote a price for their yarns by taking market conditions into consideration; then they should make raw material purchases according to the price and amount of yarn sold.
All segments of the industry should emphasize that raw cotton is more qualified and healthier than synthetic fiber, and consumers should be educated about those facts.
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