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Are Cotton Prices Weaving A Tangled Web?

By John Johnson

Market volatility created by record high cotton prices in the 2010-11 marketing year has farmers, merchants, textile executives, analysts, and others shaking their heads and wondering how long the situation will last. It also has generated uncertainty about continued demand for cotton. The volatility, also the highest on record, was most obvious in December, January and February when more than half of the days witnessed limit moves in futures prices at the Intercontinental Exchange.

Through early March, the dramatic rise in cotton prices made market risk barely tolerable for both buyers and sellers and led to a heavy financial burden required to support both physical and futures positions for many businesses, according to one market newsletter. It also raised fears of “demand destruction” which is caused when prices rise so high they discourage end users from purchasing raw cotton.

One analyst in mid-February noted some textile mills were beginning to have problems acquiring working capital to maintain efficient production levels. The squeeze on mills’ margins also may force them to switch to synthetic fibers or start blending synthetics with cotton to improve their financial health.

While the prevailing wisdom among the cotton trade has been that the cure for high prices is high prices, it may not be the case at least for the near-term. During the past five years, world cotton consumption has exceeded world production which has led to the current tight supply situation, and it cannot be corrected in just one season. In its February reports, the U.S. Department of Agriculture projected 2010-11 U.S. ending stocks at less than 2 million bales and world ending stocks at about 43 million, both of which are extremely tight.

Virtually everyone seems to agree world cotton acreage will increase in the 2011-12 marketing year. In its annual planting intentions report, the National Cotton Council predicted U.S. farmers will plant 12.5 million acres, based on a survey of farmers in January. Others predict acreage at 13.0 to 13.5 million as prices continued to surge higher in February, but even an additional one million acres, depending on abandonment and yields, will not be enough to significantly change the supply situation in the United States.

The International Cotton Advisory Committee on March 1 predicted world cotton production will increase 9 percent in 2011-12 to a record 127 million bales. World consumption was pegged at 117 million bales, up 3 million from last year. However, two key factors could make current projections inaccurate.

In addition to cotton, corn and soybean prices in the United States also are at record levels which could lead to fierce competition for acres, primarily in the U.S. Delta and Southeast. Some analysts, on the other hand, say cotton can meet the challenge because three years will be needed to rebuild cotton stocks. The other factor is weather.

A drought in China, the world’s largest producer and consumer of cotton, and new incentives for Chinese farmers to increase their wheat and rice production have caught traders’ attention. Likewise, drought conditions in West Texas, the world’s largest contiguous cotton-growing region, were becoming severe by early March while recent heavy flooding in Australia may have caused significant damage to the cotton crop.

Some analysts now say weather will be the most important factor impacting the cotton market in the coming months. They say the market remains fundamentally very bullish, but are current prices weaving a tangled web? Stay tuned.