Arecent Chinese government survey indicates that country's cotton farmers will increase acreage by 16 percent in 2004.
Consequently, pricing cotton early makes sense in what Texas Extension cotton marketing specialist Carl Anderson projects will be “an unstable market.”
Anderson, addressing the recent North West Texas Ag Conference in Memphis, Texas, said China “plays havoc with the U.S. cotton market. The market shifts without warning. Over the last five or ten years, the gap between the high and low prices for December futures sometimes hit $100 per bale.”
He says China's planting intention indicates that U.S. farmers may count on one more year of a strong export market. “China can make from 28 million to 32 million bales of cotton. A lot depends on insects and weather and the Chinese have begun to adopt Bt technology, so bollworms are less of a problem.
“If China makes a 28 million to 32 million bale crop in 2004 and then makes it again in 2005, we can expect the market to test 28 cents per pound.”
Anderson encouraged growers to look at options markets before planting the 2004 crop to hedge against falling prices during the season. “We expect a good crop for 2004,” he said, “ so we need to set a price for the worse case scenario, high yields and low prices. China could make a 29 million bale crop and the United States could make 19 million bales.”
Other cotton producing countries could push production above 100 million bales, with use at 98 million.
He likes the options market as a good tool for price protection. “If a farmer buys a 58 cents call and the market goes up, he'll lose his counter cyclical payment,” Anderson said, “but he makes up the difference on the call.”
He said buying call options protects a grower from losing higher pricing opportunities and lower government payments. A put option protects against lower prices.
He said a put on a December 04 futures price of 62 cents a pound costs 2 cents per pound. If December 04 goes to 50 cents a pound, the option value increases to 12 cents, so he comes out with a 10 cents per pound gain. At 55 cents the gain is five cents.
“Where else can you spend 2 cents and have a chance of getting 10 cents back,” he asked. “And where can you spend 2 cents and have a very good chance of getting a nickel back?
He said just before planting time usually offers the best marketing opportunity. “Last year, the best market was in October. This year the market is set to pay early. March and April may present opportunities to move some of the old crop and price new crop cotton. If the market follows expectations, it could be down to 45 cents in October.”
Last October's run was a bit of a fluke, he said. “The signal last October with 80 cent cotton was to sell two years of cotton.”
The run resulted from China coming into the market and buying a lot of cotton in a short time. “They got out and the market dropped,” he said. “The market never should have moved above 70 cents.”
Anderson said growers should work the farm program to maximize price for the 2004 crop. “Farmers get 52 cents a pound from the farm program if they take the loan,” he said. “Fixed payment will be 6.7 cents per pound. But government counter cyclical payments disappear after cotton moves above 65 cents per pound. At 65.73 cents, they get nothing.”
Anderson said a recent announcement by the USDA that a second counter cyclical payment will not be made could bring worse news. “Farmers who took a CC payment last fall need to keep their fingers crossed that they can keep it,” he said. He said cotton prices would need to rise an average of 4 cents a pound for the rest of the season. “It will take a strong rally to push cotton to a 67 cents per pound season average,” he said. “I don't quite see that.”
He said old crop supplies are very tight but new crop prospects are depressing prices.
Anderson said an early estimate of 2004 U.S. cotton of 14.5 million acres could drop.
“We're looking at three pretty good markets,” he said. “Corn is pushing $3 a bushel and the wheat market looks good. Cotton is not bad compared to what it could be.”
He said if China comes in to buy more cotton growers could see another rally. “China has already bought 4 million bales and they need another million. If they come in we could see a rally to 75 cents.”
Anderson said overall he's “bearish” on the 2004 market outlook. “Speculators are currently out of the market and March futures are not promising.”
He's also concerned about Congress tweaking the farm bill. “A payment limitation would hurt,” he said. “But even worse would be to take away certificates. That would be disaster.”