The cotton market is focused on China and for good reason. China's aggressive reserve stocks accumulation policy has upped China's ending stocks from 23% of use at the end of the 2010-11 market year to 122% of use projected at the end of 2012-13.
From another angle, China is boosting reserves over that stretch from 20.1 million bales to a projected 33.8 million bales. That 13.7-million bale hike tops projected 2012-13 U.S. exports of 12.75 million bales. USDA projects China could isolate another 7.2 million bales in its reserve during 2013-14.
China vacuuming up free supplies splits the cotton market into China and the rest-of-the-world. "The division creates great uncertainty because cotton policy in China is flexible," cautions Carl Anderson, Texas A&M University economist. "Their intentions to buy and sell at home and abroad are unknown.
China holds more than half the world's carryover stocks but uses only one-third of the world's supply. The rest of the world holds a bit less than half the world stocks, but uses two-thirds of the supply.
China rapidly building reserve stocks has rapidly tightened the supply-demand balance outside of China. The speed of stocks rising in China and dropping in the rest of the world launched the uptrend in U.S. cotton futures in November.
Stock balance differs from 1990s
In 1997-98 and 1998-99 world stocks were balanced around 50% between China and the rest of the world. "Then, the balance quickly changed in the opposite direction," notes Anderson. "In 1999-00 and 2001-02 toward the share of world stocks outside of China rose rapidly. China's share declined. The "A" Index (world price) slipped from near 80 cents in 1996-97 to almost 40 cents by 2001-02 as stocks in the rest of the world became plentiful."
Given that the rest of the world stocks are now getting tight relative to China's government controlled stock surplus, the price rally is a signal that the rest of the world needs more cotton acreage planted this spring.
Recognize ample risk exists
China already has a surplus of more than a year's use in China hanging over the market.
"The price staying above 85 cents based on December 2013 futures is a high risk situation," cautions Anderson. "China could quickly change cotton policy. Weather conditions in cotton producing countries might turn favorable. Price could drop 10 cents per pound in a few weeks.
"Producers should have a plan to set a floor on a reasonable amount of their cotton in the mid-80 cent level," he recommends. "Put options and option spreads can be used and still benefit from higher prices later."
What goes up, comes down
China building stocks has helped boost expected 2012-13 market year U.S. exports from the October 2012 projection of 11.6 million bales to the March projection of 12.75 million bales, the largest amount in two seasons. Lift from tightening stocks outside of China easily pushed December 2013 futures through the 85-cent barrier.
Recognize that a change in Chinese policy could change price lift to price drag, almost overnight.
On 2012 crop, USDA projects a U.S. average farm price of 70 to 73 cents.