Rebalancing Global Cotton Positions
February 9, 2012 Markets are markets balancing between supply and demand through various price mechanisms is what creates the marketplace. Looking into 2012, this year will be no different than past seasons as it will bring its own challenges. Price advancements early in 2011 were driven by low supplies and perceived demand which turned into panic buying, which encouraged production around the world. It also caused large transformations in the downstream supply chain at a level not seen in a while. Now as cotton prices return back to a more practical level these modifications must be rebalanced into the decision making process which could cause some long-term ramifications for cotton.
Cotton’s elevated prices quickly became a major concern for retailers and sourcing agents who in the past watched the market, but at a distance. Procurements that were usually based on semi-annual pricing, quickly moved to monthly and in some circumstances weekly. Even though some point out that the impact on retailer’s margins percentages are relatively small, it must be noted that the overall cost remains the same throughout the supply-chain and can be quite large in dollar terms.
At the same time, margins were shrinking so the desire to source different fibers came into the equation by multiple segments of the supply chain while balancing the demand of their consumers. This will be a long-term impact as mills re-tooled to incorporate more man-made fibers (MMF) into their blends or shifted from cotton rich products to a cotton/poly blend. Looking at U.S. import data we see that cotton share in volume terms has lost somewhere around 2% in 2010 and as much as 4% in 2011. These figures are probably larger in retail consumption in Asian markets.
A key challenge for parts of the supply chain from fabric manufactures to the retailers is risk management in a declining market. Their first and second strategies are to go short on stocks and delay ordering. This has been witnessed as retailers place smaller base orders upfront with limited chase orders as the season approaches. In the U.S., for an example retail stocks are 5% to 10% lower than 2008, while sales exceed the 2008 level and expanding as retailers have learned to do more with less.
Rising cotton prices in the first quarter came from mill purchases and sparked other mills to purchase more even though spinners did not have yarn orders. This created a double whammy. First, when orders did not come, prices started to fall, while yarn stocks needed to be sold for cash and were pushed on to the market. Also, polyester fiber and yarn manufacturers followed the same pattern as they too built-up inventories which needed to be liquidated. Retailers continued to delay orders by a month or two to the very last minute in this spiraling downward move in the fall.
Estimating consumption this coming year requires one to evaluate all of the above issues in regards to rebalancing the following relative large alterations with sourcing patterns, size of orders, retail stocks, supply chain stock levels, financing and cotton to polyester blends, all before you even start to look at final consumer demand being impacted by the macro environment. Barring no major turnaround in the global economy, good or bad, the 2011/12 season should contract with 2012/13 annual mill use recovering only slightly at 1% to 2%.
Looking at the other side of the cotton balance sheet, world production, after exceeding world mill use the past two years, should come under pressure. Even though the current surpluses started to alleviate upward price pressure, China’s strategic reserve purchases may support prices at a relative elevated market equilibrium level, stimulating production internally and in markets with low cost production. Other areas around the world will depend more on water availability and competing crop prices. In conclusion, assuming no major weather event, the crop could fall back to the 2010/11 level, though that would still be above mill use adding to ending stocks.
Evaluating the major parameters impacting cotton prices, China’s reserve policy in how much stock they acquire and when it will be released is the thing to watch this season. China’s first priority is to support “local” farmers and secondly to stabilize “local” prices. With that noted, they are not known to acquire losses with their strategic stocks. Estimating their current purchases domestically and abroad comes close to the global surplus that was originally expected in 2012.
Assuming no global economic disaster, this would imply prices should glean some support over the coming year, but would be limited on the upside at which point the Chinese reserve starts to release.
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