What’s Next After Cotton’s Pricing Drama?
September 4, 2022 Remember playing Chutes and Ladders as a kid (or with your kids and/or grandkids)? It’s a simple game of rewards and penalties. Spin the wheel and move around the gameboard. If you were fortunate to land on a square with a ladder, you got to climb up several rows toward the finish. But land on a square with a chute and…well, you get the idea.
Over the past year or so, I’m not sure the cotton market knew it was in a high stakes game of Chutes and Ladders. After all, cotton prices have always proven to be cyclical, but the extended period of near-record prices kept the good times rolling. Until it didn’t.
In mid-June, cotton prices tumbled from around the $1.40 mark back below a dollar in one day. It was shocking, surprising, and had no clear reason. But it wasn’t just cotton. That same day, the entire commodities market crashed. Take your pick: corn, soybeans, steel, nearly everything. And once the dust settled, the questions started.
What Happened…and Why?
“I think it was a surprise to a lot of folks to see the market pull back to the magnitude it did and so quickly,” explains Hank Reichle, President and CEO of Staplcotn, during an interview for the Cotton Companion podcast. “Cotton was not alone. We saw a broad-based sell-off in commodities in general.”
Reichle notes that conversation about a possible recession started increasing about that time, catching the attention of speculators who played a large role in driving the cotton market skyward. Quite simply, he says, enough people with the same mindset headed for the exit and put the resulting pressure on prices.
“The macro outlook certainly became cloudier and people became more concerned about an economic slowdown and a decrease in consumer spending that would be related to a drop in their discretionary income, in particular,” says Reichle. “So, in a futures market, people start to look to the future and say there are likely some hedge headwinds and cuts in consumption coming – particularly compared to the tailwinds that we’ve had for consumption over the past year to 18 months.
“But, at the same time, we saw nothing but a strengthening of the fundamentals from the supply side argument,” he adds. “U.S. crop prospects continue to shrink primarily because of what’s going on with the drought in Texas, and we have some pockets in the Memphis Eastern area (Mid-South) where the crop is also struggling with drought. But we have some great areas, too.”
Is it possible that the market was too focused on an ample supply of cotton, given USDA’s initial production projection of 16.5 million bales rather than the increasing tightness in U.S. production? If so, then what’s the market reality? Reichle and other cotton economists believe that final production number will likely be in the 14-to-14.5 million bale range.
“That would be a small crop that yields a variable, tight stocks-to-use ratio,” he points out. “That means if we do see a slowdown in demand, we won’t fell it as much because we’re already at that level where we have a lot less cotton available than we normally sell. So, in effect, we’re already sort of rationing demand – not necessarily because of price, but because we simply don’t have the bales.”
What Should We Do from Here?
The ladders are still out there, and some positive price climbing has already begun. But as Dr. O.A. Cleveland, Professor Emeritus of Agricultural Economics at Mississippi State University, pointed out in one of his recent weekly market reports, it’s going to require patience, patience, and more patience.
“Trading ranges have remained in the 400-to-550-point range, and that should be enough to keep traders interested,” he says. “Prices need to sit in the 95-to-99 cent range just to regroup and not let the market get ahead of itself. Don’t expect it to be in any hurry. Market psychology suggests the dollar mark will find many sellers and slow the advance to higher prices.”
“For producers who are currently trying to figure out what to do, I would say don’t panic, take a deep breath, see where you are, see what protection levels you end up having, and think about what’s a reasonable path moving forward,” advises Dr. Aaron Smith, Extension Cotton Economist with the University of Tennessee.
“I think the market overreacted, and we’ve already seen it come off those lows pretty strongly,” he says. “A lot is going to depend on if we can stabilize some of the demand concerns. I think there’s more bullish news on the supply side that’s not quite factored into the market yet. And we don’t know what’s going to end up happening in terms of hurricanes and harvest season.”
Smith offers several suggestions for growers to consider when moving ahead to market this year’s crop.
If you’re concerned about losses, find out what your options are. Find out what you’re looking at in terms of indemnity payments and look to see where your trigger yields are. “If you set that projected crop insurance price back in the spring, $1.03 is a pretty good safety net right now,” says Smith. “Look and see what you’ve done in terms of pricing relative to where your yield expectation is.”
If you want to be a little more aggressive and try to participate in a market rally (if it does materialize), buying or using call options might be a play to consider. However, it’s not without its risks, and it’s not for everyone. “I don’t necessarily think we’ve hit the top of the rebound yet,” points out Smith. “I look more towards the March contract where you have that inverted spread as an opportunity. But it’s kind of a double-edged sword. The longer you’re looking out, the more you’re factoring in uncertainly because of the economy. Find out where you’re at and what you’re comfortable with, then look at the available strategies that you might want to consider moving forward.”
“When you look at it,” he adds, “I think there’s more upside potential than downside risk when we’re talking about that 90 cents on the March contract.”
The ladders are out there. It’s time to go find them.
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