If cotton prices have, in fact, bottomed out and begun what many hope will be a return to profitability, U.S. cotton producers may owe a debt of gratitude to “friends” in some rather unlikely places.
The U.S. cotton program gets some of the credit for prices changing course, but actions by the governments of China, India and Pakistan have also played a role in stopping last fall's downward spiral of cotton prices, according to veteran market analyst Ed Jernigan.
“For all of the bad news we've had, it appears that for now, at least on the futures level, cotton prices have bottomed,” said Jernigan, managing director of FCStone Asia.
Speaking at the Cotton Economic Outlook Symposium at the Beltwide Cotton Conferences, Jernigan said so many reports of bad news were floating around the cotton and financial markets toward the end of last November that some market participants were questioning how much more of that commodity they could handle.
“As you know, these events did not happen, and things have actually improved since that moment in time,” he said. “The large Chinese mill everyone was concerned about did not go bankrupt. Those rumors were false, and it is actually making money. The Chinese did not lay down or back out on some contracts, and shipments have actually picked back up to Pakistan.
“So the world did not come to an end, and prices have begun to rally. The second thing that has happened is that four major government efforts are underway to support prices, something which has never happened before in the history of the cotton business.”
The first of those is the U.S. cotton loan program, which supports U.S. prices when prices drop below the Commodity Credit Corp. loan rate, which they did last fall. The second is China's National Cotton Reserve Corp., which buys cotton when the government believes prices are too low and sells cotton when it believes prices are too high.
“Its job basically is to stabilize prices,” said Jernigan, who has traveled extensively in China and Southeast Asia and speaks frequently at merchant and manufacturers' seminars throughout that part of the textile world.
“The Chinese farmer has been devastated by cotton,” he said. “Last year (2007), he received six yuan per kilogram for his seed cotton when he brought it to the gin, so he was very excited about planting cotton in 2008. It looked like a very profitable crop. They've done a good job of improving technology. He expected he would get seven yuan a kilogram this year.”
That did not happen because of the economic slowdown that has reduced demand for textile products. Analysts who were forecasting 2008-09 Chinese cotton consumption as high as 55 million bales (Jernigan was predicting 52 million) have cut their estimates to 45 million bales.
“This has been an earth-shattering event,” said Jernigan. “What it's all related back to is that over the past three or four years when China's cotton consumption was booming and the rest of the world was booming, there was a rapid expansion in textile mill capacity. Basically, more mills have been put in place than the demand warranted.
“We've been expecting that at some point there would be a rationalization of this excess capacity. We thought it would happen over several years, but it's all happened in about six months time. Now as much as one-third of China's mills are not operating or have gone bankrupt. Others have changed their operating schedules.”
As a result of the slowdown, prices received by China's cotton farmers have ranged from a low of 4.5 yuan per kilogram to a high of 5.2 yuan, causing widespread panic about how to stabilize cotton prices in China.
Chinese growers do not have direct government loans as U.S. farmers do; they only have the National Cotton Reserve Corp. The latter has been conducting a gin modernization program that has given it more clout when it comes to buying cotton.
“When prices began falling, the National Cotton Reserve Corp. said they would buy cotton at substantially above the market price, but only market-sized bales HVI-classed and produced by the gin,” he said. “They bought a couple of hundred thousand tons. That didn't work. They decided to buy a million tons and took the total up to 1.3 million.
“That did not stabilize the price so they bought another 1.5 million bales. Put that together and eventually more than a third of the Chinese crop will be placed in the state reserve and be held by the government until prices reach a level where they want to release that cotton back into the marketplace.”
In India, the government has raised the minimum support price that can be paid to cotton farmers. The MSP has never been much of a factor in Indian cotton prices, but the Cotton Corp. of India vowed that the 2008 crop would be different.
“They got the commitment from the government, which was going into an election, to spend the money to support the farmer,” said Jernigan. They changed the price based on their calculation of what it costs to grow cotton in India and to offer a small profit. So they raised the minimum support price higher than it's ever been before (by 33 percent to 40 percent).”
This year the Cotton Corp. will buy at least a third of the Indian crop and sell it into the market for export. “But they're in no rush to do so because they've been well-financed by the government,” he said. “Last year, when they had a record crop, the price went down to where Indian cotton was the most competitive in the world. Now U.S. cotton is the most competitive because of the way our marketing loan program works.”
The Trading Corp. of Pakistan has also launched a program of buying seed cotton to help stop the fall in cotton prices in that country.
“So all these factors together — the actions in the United States, China, India and Pakistan — have helped the cotton market bottom and have put a floor under world prices,” he said. “So it's not all gloom and doom for cotton at this point.”
Nevertheless, Jernigan predicted U.S. cotton acres will decline again in 2009 given the higher returns growers experienced with corn and soybeans in 2008 compared to cotton. “We're not trying to put an exact number on it today. Soybean prices have rallied, closing over $10.30 yesterday. It's a moving target, but obviously cotton acres will be down.”
The most encouraging news for U.S. growers may be that cotton acres will also be down sharply in China this coming year because of the economic train wreck that hit Chinese cotton producers in 2008.
“Many Chinese farmers rent land from their neighbors to develop a little economy of scale,” he said. “Those farmers who did that in 2008 lost money on cotton. You can imagine how dramatic that is because they have to pay land rent and for extra labor.”
A recent survey by the National Cotton Marketing Service shows that cotton planting will be down 17 percent in China in 2009. At the same time, cotton will be going into the reserve so the supply will tighten dramatically over the next 12 months.
India, which is believed to have produced a crop of 31.5 million bales in 2008, will “probably remain the cotton king for the moment because the government's minimum support program will encourage farmers to grow cotton,” he noted.
“Supplies will be tightening dramatically throughout 2009. It does appear that because of the four government support programs in place around the world prices have bottomed. They may not go anywhere too fast. But, while the rest of the economy may not improve until 2010, with cotton prices we probably have seen our lows for now.”