Optimistic Marketing – With a Dose of Caution
As the calendar turned to 2018, the cotton industry was almost giddy with optimism. Prices had moved back in to the mid-70 cent range, as demand and consumption are up around the world. And the new seed cotton program approved by Congress as part of bipartisan budget legislation on February 9, moved cotton back into the Farm Bill as a Title I commodity – and helped push the excitement level even higher.
USDA’s January World Agricultural Supply and Demand Estimates report reinforced the optimism. Although the agency lowered expectations for U.S. production to (only) 21.3 million bales with a carryover of (a mere) 5.7 million bales, the big news came in global consumption. USDA now forecasts that world consumption will grow at a 5.2% annual rate in the 2017/18 marketing year – more than double its long-run level.
Yet in spite of the excitement and optimism, Dr. John Robinson says there are still watch-outs to keep an eye on.
“Officially, the USDA balance sheet for the 2017 crop looks awful,” says Robinson, AgriLife Extension economist. “We’re doubling ending stocks year over year, and it’s been that way in every report and forecast for the past six months. The fundamental conclusion from that is that price weakness is coming.
“I may be the lone voice in the wilderness on that,” he quips. “It’s wonderful now that prices have climbed to where they are, because we’re starting to establish the crop insurance price by the average of these settlements. I think that’s great, and I hope I’m wrong, and that prices will stay above 70 cents.”
Increased demand should continue to drive exports higher, notes Robinson. That means the balance sheet is likely to remain neutral and help keep prices where they are. Plus, early acreage projections for 2018 peg the U.S. crop in the 12.9-13.1 million acre range.
“We’re going to plant more cotton in Texas,” says Robinson. “And it’s dry, so there will be some trade-offs in terms of production. But if we just have an average crop following a big crop in 2017, we’re going to be chewing through ample supplies. And, to my way of thinking, it just keeps the possibility of price weakness in the mix. It could come very unexpectedly, when you consider that spec buying has given us this rally since November. A major risk event could cause them to back off their positions quickly.”
Start Marketing Moves Now
With good prices on the board this early in the year, Robinson believes growers should consider hedging earlier than normal.
“Even before the market rally in October and early November, the volatility in the market was actually pretty low,” he says. “Option premiums were not that high because of low volatility. I was penning examples of buying puts and put spreads on December 2018, and they were amazingly affordable considering how early and far out we are.
“If your marketing plan is to contract bales, try to do some of that at these levels,” he adds. “If you do your own hedging, consider doing some. Basically, it’s not too early, prices are at a good level now, and the future is always uncertain.”
Robinson cautions, however, that any outlook is just an educated guess. Should prices drop from where they are to the lower 60s, nothing will protect producers from that loss. “This is a zone of unprotected price risk, and, with prices being good now, I would be doing something with a portion of my expected production,” he notes.
What Will China Do?
The longer term solution to market prices could come from China, where the government has been whittling down the cotton reserve they built up from 2011-2013.
“There’s an emerging issue in China,” says Robinson. “And when it emerges, it’ll be positive and uplifting. They had 60 million bales in reserve, and we were all worried about what might happen when they finally started letting it move to market. They cut back on their imports and started using what they had in the reserve. They have now pulled the reserve down to 20-something million bales. And their imports have been only in the 5 million bale range for the past two years.”
At some point, Robinson believes two things are likely to happen. First of all, the Chinese are going to pull the reserve number down to a level they want to maintain. When that happens, they will still have a 14-15 million bale gap every year of excess consumption over production, and they’ll get back into the import business.
“Just as a recollection, they used to import 15 million bales annually – half of which would come from the U.S.,” recalls Robinson. “That’s when they were our number one export destination. When they get back to being the top buyer, it will lift the market. And that will be a very positive thing.”
The second consideration is that the bales left in the reserve will likely need to be rotated. That translates into extra buying to cover what China wants for mill use and for what they want to store.
“There’s definitely a bullish picture of the return of China as a major importer,” says Robinson. “It will step us back up to a more permanent higher level.”
Things to Remember
The year-in, year-out advice from a farm management economist still holds true moving into 2018 production, states Robinson.
“Cotton is just another commodity, and we have to be the most efficient low-cost producer,” he says. “In the U.S., the only way we can be the low-cost producer is to have really good yields, but still know the worth of inputs and input purchases. We have to be efficient across the board.
“The way it’s been measured in surveys of top farmers is that the most successful people tend to be about 5% better on everything,” he notes. “They sell at a 5% higher price, and save about 5% on production. We try to cast it in a doable way.
“Do small improvements across your whole operation to be the least-cost, efficient operator. It’s the only way to make it with a commodity product.”
From Cotton Grower Special Texas Report – Winter 2018