China’s Soft Power Tested as Sale of Cotton Stockpile Looms

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HONG KONG—Global cotton prices have plunged in recent weeks as speculation mounts that China is getting ready to sell some of its 11 million metric ton stockpile—enough to make 10 billion pairs of jeans.

Commodity analysts expect China to hold a new cotton auction in the next few months, its first since the end of August.

While China sells nearly all of its cotton at home, it is such a big player in the market that unloading a chunk would depress global prices by reducing how much foreign cotton Chinese businesses buy. China holds about 60% of the world’s cotton stockpiles and is responsible for just less than a third of global consumption.

In addition, China has tightened import quotas for cotton, leading to a 41% fall in imports in January compared with a year earlier. That means global cotton sellers have less access to the big China market.

The expectation of a new round of selling by China has pushed down prices on the Zhengzhou Commodity Exchange to their lowest levels since 2004. Meanwhile, the benchmark ICE Futures U.S. exchange has cotton trading at around its cheapest level since 2009, having fallen 11.7% since the beginning of 2016.

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“Until those [Chinese] stocks are cleared, it is going to be hard for cotton to break away from current levels,” said Paul Deane, agricultural commodity analyst at Australia and New Zealand Banking Group, which is bearish on cotton.

China’s National Cotton Exchange said it hadn’t been notified of further auctions from the National Development and Reform Commission. The commission was unavailable for comment. However, the U.S. Department of Agriculture said there “are numerous unofficial indications that the [Chinese] government intends to pursue a more aggressive reserve stocks sale program in the spring and summer of 2016.”

But clearing its stockpiled cotton won’t be easy—or painless—for China.

In the July-to-August auction, the National Development and Reform Commission wanted to sell 1 million tons of cotton. It fell way short, selling only 63,413 tons.

Global prices have dropped 9.5% since then, so China will need to put up its cotton at a far lower price if it is to sell.

One factor putting pressure on China to sell: Cotton deteriorates, so it can’t simply hold supplies for years with hopes of rising prices.

The stockpiles date back to a government program introduced in March 2011 to improve the livelihoods of domestic cotton farmers by setting a floor for prices. But with global cotton prices dropping, China chose to store the cotton rather than sell it on the global market.

The result, according to the USDA, was a doubling of the world’s stockpiles, which further depressed prices. USDA estimates of cotton stockpiles are slightly higher than China’s.

Harvest time last September in Hami, also in the Xinjiang Uighur Autonomous Region.

Harvest time last September in Hami, also in the Xinjiang Uighur Autonomous Region. PHOTO: AGENCE FRANCE-PRESSE/GETTY IMAGES

China has since introduced reforms to its agricultural sector, including ending the price-support program for cotton. But that won’t help it with its huge stockpile—which is enough to make three times more jeans than the total sold globally in 2015, according to Euromonitor.

However much it sells at its next auction, China will lose money.

China bought cotton for the equivalent of $2,950 to $3,200 a ton during a period when the median monthly global price was $2,000 a ton, according to the U.S. Department of Agriculture. China sold some of these stocks for an average equivalent price of $2,175 a ton in last year’s auction—a loss of at least 26% on its original investment.

The Commonwealth Bank of Australia said in a note that China will need to set prices lower to sell its stockpiled cotton, bringing them more in line with depressed global prices.

If it does sell at lower prices, the USDA predicts, China may be able to cut its reserves 13% by July 31 of next year.

“Some of it has certainly deteriorated over time“ said Nick Hungate, global head of cotton at RCMA Commodities Asia Pte., who said markets have speculated that much of the higher-quality cotton has already been sold and instead, it is the lower grade cotton that has been left.

Also cotton’s rival—synthetic fiber—is more competitive because oil, one of its feedstocks, is cheaper. That is reducing demand for cotton.

Adam Davis, head of commodities at Melbourne-based Merricks Capital, which runs a $350 million soft-commodities fund, offered a gloomy assessment for what’s ahead.

“Competing fibers are a big headwind for cotton—that factor alone would typically be a bearish issue for cotton,” Mr. Davis said. “But given that we are going through this destock at the same time it makes it the perfect storm.”

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