- If you want to understand China's agricultural policy, look no further than its people. Keeping them happy drives many of the government's economic decisions. For this reason, China is likely to keep its huge reserve of cotton off the market for the time being.
Is there a method to the madness of China’s cotton policy? Kelli Merritt, cotton farmer, broker and merchant from Lamesa, Texas, thinks so. And it’s given her reason to believe that China may hold on to its huge reserve of cotton for a while.
Merritt, speaking at the Ag Market Network’s March conference call, says her thoughts are based on analysis by Fred Gale, a senior economist with USDA’s Economic Research Service. Gale, who lived in Beijing for two years, believes a number of factors rule Chinese agricultural decisions, even its latest to build its share of world cotton supplies to over 40 million bales.
- China wants to keep those in the rural economy self-sufficient. When China believes a crop needs to be produced, they provide farmers with incentives to produce them.
- China’s cotton policy is cognizant of social stability. They want to control rioting in the Xinjiang province, where most of the cotton is grown. Price supports are designed to keep groups there happy.
- China fixes cotton prices to growers based on production costs plus a profit. China also wants to maintain an adequate cotton-to-grain price ratio. China isn’t concerned about whether their prices compete internationally. It all depends on what they do want to do on the domestic front.
- Since 2008, China has been raising support prices not only for cotton but for corn, soybeans, rapeseed and hogs. “Those are the areas where they are really trying to increase price supports,” Merritt said.
- Traditionally, China tries to keep the wheat-to-cotton price ratio at 8.4 to 1. But this year, the cotton price floor was set at 10 to 1. It doesn’t necessarily mean that they’re trying to encourage cotton planting.
- When China purchased domestic cotton at very high prices in 2011-12, they believed that cotton prices were going to stay high, or higher, and not fall back under a dollar a pound. That prices have fallen is not a big concern, however, because what they paid for the reserve cotton is a small amount of their overall budget. They won’t mind holding it for years.
According to Merritt, the latter “provides a fundamental reason to see cotton prices where they are and possibly move even higher. “But we still need pullbacks. Hopefully were going to get a pullback from where we are right now. But as far as a huge fall, I really don’t see a reason for it.”
If China continues to hold its reserves, bulls could stir once again as cotton supplies are drawn down “the closer we get to summer,” Merritt said. “We’re going to realize there really isn’t much cotton out there available. Most of it is out of the farmers’ hands at this point.”
But the market can always be counted on to do the unexpected, a good reason for producers to put on hedges, Merritt says.
“We are above breakeven where prices are now. As business operators, I think now is a good time to be locking in a third to a half of the crop and have a plan to get more of it hedged if this market moves up.
“If you're extremely bullish, get some contracts and buy calls. But just don’t fail to have a plan. Don't fail to pay attention to what this market is doing. There are always surprises.”
USDA’s March World Agricultural Supply and Demand Estimates were friendly to cotton. Noted Texas A&M Extension professor emeritus Carl Anderson, “China has been buying a lot of cotton in the last few weeks, which in turn lowered U.S. ending stocks to a workable level, 4.2 million bales, 300,000 bales less than last month.”
World carryover came in at nearly 82 million bales, “but we have to remember that 54 percent of that is in China,” Anderson said. “So the rest of the world has 46 percent of those stocks.”
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Another positive for price support are the unfixed call positions in December, “which are at the highest levels of the year,” Merritt said. “It’s also spiking fear in the mills, with the prices continuing to march higher.
Other observations about China:
Merritt said one reason to suspect that China is quickly becoming a developed nation – they’re now starting to worry about rising labor costs.
China has already put in a 7 percent to 10 percent increase in prices for competing crops to cotton such as wheat and rice for 2013.
Chinese cotton policies have had an adverse effect on Chinese textile mills, Merritt noted. “They’re spinning less cotton in China now, and they’re importing a lot more cotton yarn than normal. In their domestic mills, they are going to more man-made fibers.”
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