Cotton prices: The top 10 most important drivers

 

This is the fifth in a series of articles looking at the top 10 most important drivers behind some of the main commodity futures prices. Episode 5 looks at cotton prices.

1) Economic growth

A shaky economy tends to dent consumer spending on discretionary items such as cotton sheets, shirts, and jeans. It may also lead to a substitution effect towards cheaper man made polyester clothing and away from cotton.

2) Government policies

Many cotton producing countries have sought to insulate their farmers and the textile industries upon which they depend from external competition (see driver no. 4), changes in these policies (eg, subsidies) can have a disproportionate impact on other global cotton producers. For example the US government has subsidised US cotton farmers since the 1930’s, to a greater extent that farmers of other crops. However, these subsidies distort global flows of cotton.

3) The weather

Changes in weather patterns resulting in a lack of rainfall, particularly at a certain time in the planting cycle can significantly impact overall cotton production. Cotton requires plenty of sunshine, fertile soil and preferably no frost. Because it needs 24-48 inches of water annually, transplanting cotton from its original subtropic habitat is difficult. As cotton production has progressed around the world, adequate irrigation has become essential in growing robust plants.

4) Chinese stock-building

Between 2011 and 2013 China implemented a cotton stockpiling program, purchasing the fibre if prices fell below a set floor. The program acted as a price support for Chinese cotton farmers, guaranteeing them a minimum price for their cotton harvest. By the end of 2014 the International Cotton Advisory Council estimated that China held 60% of global cotton stockpiles. Just as constructing this stockpile was one factor leading to a surge in cotton prices so any attempt to off load the stockpile is likely to pressure global cotton prices.

5) The price of synthetic fibres

Cotton competes with polyester in the worlds fibre and apparel markets. The post-2009 jump in cotton prices led China to vastly expand its capacity for purified terephthalic acid (PTA), the oil-based raw material for polyester. PTA prices in China have declined sharply since mid-2014 improving the price competitiveness of polyester vs cotton, a further drag on cotton prices. The sharp spike in the price of cotton during 2010 and 2011 forced many clothing manufacturers to switch to cheaper man-made fibres instead. Despite lower cotton prices since then, clothing manufacturers have been reluctant to switch back.

6) Oil prices

Cotton has the largest per-acre energy costs of all agricultural commodities and so so changes in the price of oil can also directly affect the price of cotton. According to a recent report the historical correlation between cotton and crude is the highest across all commodities at 0.45:1. In addition changes in crude oil prices affect the price of polyester, a substitute to cotton in the manufacture of textiles.

7) The US dollar

Like most internationally traded commodities cotton is priced in US dollars. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa.

Cotton prices have a relatively high inverse correlation against the dollar of around -0.47.

8) The price of competing crops

Although cotton competes to some degree with wool and synthetic fibres the land and resources upon which the cotton is grown has to compete with other agricultural crops, such as corn and wheat which may enable the farmer to fetch a higher price and better returns than cotton. Higher prices for other crops may result in farmers planting less cotton, in doing so leading, eventually to higher cotton prices.

9) Main producers

The medal for largest cotton producers is closely fought between China and India. Following a distant third is the US, followed by Pakistan and Brazil. The most up-to-date information on crops comes from the US Dept. of Agriculture. Reports on US sowings and harvests as well as projections for other main producers if watched closely by cotton traders.

10) Seasonal factors

Cotton futures prices tend to peak around March/April, but be at their weakest between August and November.

Previous episodes

Natural gas prices: The top 10 most important drivers

Copper prices: The top 10 most important drivers

Livestock prices: The top 10 most important drivers

Sugar prices: The top 10 most important drivers

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5 factors affecting cotton prices

Is cotton hanging by a thread? Will soft growth fray the cotton markets nerves? Will a soft market leave cotton with no cushion or is the cotton market unraveling?

Whatever, it is the only major commodity futures market to have registered a significant increase in price during 2015 – up 7% at 64 cents per lb.

Feld mit reifer Baumwolle.jpeg
Feld mit reifer Baumwolle“. Licensed under Public Domain via Wikimedia Commons.

1) Declining cotton production

The US Department of Agriculture, in its first forecasts for 2015-16 forecast world cotton output falling 5.4% to 133 million bales, sapped by lower, or flat, harvests in all major producing countries. US output will fall particularly far, by 2.1 million bales to 14.1 million bales, a reflection of lower sowings due mainly to relative prices and net returns that favour alternative crops.

Chinese output will fall 2.0 million bales to 28.0 million bales, the lowest since 2003-04, a reflection of a revised subsidy regime that favours farmers in Xinjiang, the top growing province, over producers in other areas (more on that later).

2) Higher economic growth

A shaky economy tends to dent consumer spending on discretionary items such as cotton sheets, shirts, and jeans. However, according to the USDA consumption will grow at an “unusually high rate” of 4.2% in 2015-16, lifted by the knock-on effects of stronger world economic growth. Despite this world inventories are seen ending next season at 106.8 million bales, equivalent to some 11 months’ needs.

3) End to Chinese stockpiling

In China Beijing has pledged to end a costly stockpiling program that has artificially inflated cotton prices and replace it with a subsidy program instead. However, the Xinjiang Production and Construction Corps (XPCC), a quasi military body that employs about 200 thousand in the cotton industry in Xinjiang is resisting calls for change.

XPCC which produces around 30% of China’s cotton has been keeping prices around $80 per tonne higher than other producers. The group may have to slash its price later in the season if the state doesn’t intervene and purchase its leftover stock, putting pressure on benchmark local prices while also weighing on international cotton prices.

Another factor is the quality of the cotton bales held in storage. If the quality of the cotton in the reserve is poor, then Chinese import demand will persist, or perhaps even improve, because quality foreign cotton will be needed to blend with inferior Chinese cotton. There are no statistics on quality however although some estimate that about half of the Chinese reserve is likely to be of inferior quality.

4) Falling oil prices

Cotton has the largest per-acre energy costs of all agricultural commodities and so so changes in the price of oil can also directly affect the price of cotton. According to a recent report from Societe Generale the historical correlation between cotton and crude is the highest across all commodities at 0.45:1.

Cotton competes with polyester in the worlds fibre and apparel markets. The post-2009 jump in cotton prices led China to vastly expand its capacity for purified terephthalic acid (PTA), the oil-based raw material for polyester. PTA prices in China have declined sharply since mid-2014 improving the price competitiveness of polyester vs cotton, a further drag on cotton prices.

5) Seasonal factors

Finally, cotton prices tend to peak around Feb/Mar before bottoming out in August.

Related article: Which commodities are most affected by lower oil prices?

 

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Cotton prices hit 21-month low

Cotton futures prices fell below 70 cents per lb on Wednesday, the lowest level since November 2012. High cotton prices at the start of the planting season (they peaked at 94.75 cents per lb in May) and weak prices for other crops such as corn encouraged US farmers to increase the amount of land they devoted to the crop. According to the USDA cotton growers in the US planted 11.4 million acres, up 9.3% compared with 2013. An easing in drought conditions in key producing state Texas also helped – a year ago more than 12% of the state was experiencing exceptional drought, now that area is down to 5%.

Reflecting better prospects for US output and weaker growth in consumption the International Cotton Advisory Committee (ICAC) forecast that cotton stocks in countries outside China (more readily available to the world market) will rise by 7% to 8.7 million tonnes at the end of this season (31 July) and by a further 15% to 9.7 million tonnes at the close of the 2014-15 season. With China’s reserve policy also coming to an end (previously guaranteed high prices for domestic Chinese mills encouraged significant imports into China), high stock levels suggest continued downward pressure on cotton prices over the next year.

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