The USDA keeps “finding” more cotton (NYBOT:CTH14) inventories. Lower Chinese output constituted the only significant production or consumption revision to the 2013-14 marketing year in the December crop report. But 2012-13 ending-stock estimates were increased, putting 2013-14 ending stocks at yet another record high of 96.41million bales, or an astounding 87.9% of consumption.
The recent rally in cotton prices has some rationale. There were several bullish developments, two of which involve China. On the supply side, early frost and snow in key growing regions lowered yields. The USDA lowered its estimate for the Chinese crop from its November estimate by 500,000 bales, to 32 million bales.
Actually, traders were surprised by the conservative downward revision. Coming into the report, the China National Cotton Reserves Corporation estimated that the damage to the crop was far more extensive, putting output at only 30.7 million bales. So it’s a good bet that the January USDA report will trim its estimate further.
Then, on the demand side, the level of Chinese imports will ultimately determine the price of cotton. China is the single largest buyer of U.S. cotton, despite the fact that its inventories are bursting at the seams. Mills import cotton because the amount of high-quality cotton in the Chinese stockpiles is limited. There were concerns that the government was planning to restrict imports to make a dent in the burdensome inventories by changing the import tariff system. Bulls were pleasantly surprised when the government instead announced changes that would effectively maintain import incentives.
The other bullish issue – of a longer-term nature – is that rising production costs may curtail planting for the upcoming 2014-15 season. The world may very well be awash in cotton now, and it may take some time to reduce inventories, but that situation will not last forever.
When cotton sold off to 77¢ per pound in November, it touched very close to the cost of production. In the U.S., for example, yields vary widely from region to region, but at the national average of about 800 pounds per acre, the cost of production is about 75¢ per pound. Soybean farming – in particular – is more profitable, and it is quite reasonable to speculate that cotton acreage will shrink even further this coming spring.
Consider that this past season, planted cotton area was 10.34 million acres, compared with 12.31 million acres in 2012-13 and 14.74 million acres in 2011-12. Our associate, John Bondurant, who is a commodity fund manager and soybean and cotton farmer, tells us that there has been divestment of cotton intensive equipment, a clear indication that farmers are scaling back cotton farming. Farmers have been selling their cotton pickers. A new picker costs about $650,000. With overall costs rising – as pointed out above – and with the lure of planting more profitable crops, there is little chance that farmers will be taking the risk to repurchase expensive machinery.
For the other significant producing nations, China and India, the pattern of declining crop size is not quite as stark as in the U.S., but certainly there is no output growth. Chinese cotton area for 2013-14 was down 6.5%. Indian production has hovered around 29 million bales since the 2011-12 season.
The market’s current focus is on the prospect for a pickup in Chinese imports. The evidence continues to suggest that this is not happening. U.S. exports are forecast to fall by 23% this season. Total export commitments to date are only 19% behind last year at this time, but Chinese purchases, the ones that count, are 61% behind last year. The changes to the import-tariff regime should bolster sales to China to some degree, but there is a lot of catch-up to be achieved.
Regardless of the long-term implications of near-certain smaller crops down the road, it is hard to imagine seeing a sustainable bull run with the massive overhang of Chinese stocks that, according to the USDA, are equal to a staggering 159% – yes, 159% – of usage.
Remain short as per our Sept. 12 recommendation. Lower stops to 86¢-per pound, basis March, close only.