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Developments in the cotton price over the next three months are likely to be heavily influenced by drought in Texas and Chinese cotton reserve purchases. However, with cotton one of the most sensitive commodities to the global economic climate and the increased speculative interest in cotton by non-physical funds the cotton price may be more reactive to the outlook for the 2012/13 crop season and the latest economic data releases.
Background
US cotton futures prices slumped to 85c per lb in mid-December, down from 154c per lb at the same point in 2010 and down from over 200c per lb back in March 2011. Cotton futures fell during November and December after estimates of global cotton production for 2011/12 were revised upwards. However the onset of drought in Texas, a key cotton producing area, due to the la Niña weather pattern, Chinese purchases of US cotton for its own cotton reserve and forecasts of reduced cotton production acreage in 2012/13 have supported prices since then.
Surge in bullish speculative cotton positions
Speculative interest in cotton futures has increased since mid-December with CFTC reporting net long positions rising from 8k contracts to 30k contracts as of end January with open interest rising by 15% (see latest Commitment of Trader report here). In the last few weeks it has reported that significant speculative funds have entered the market with target prices of $1.18-$1.20 per lb by July.
The timing of the surge in speculative interest coming in anticipation of the announcement late January that the US Federal Reserve would publish its interest rate forecasts for the first time. In reality the Federal Reserve stated that benchmark interest rates will remain ‘exceptionally low until at least 2014′, a year of ultra-accommodative monetary policy more than the market expected which was bearish for the US dollar but bullish for commodities.
Data from the CFTC revealed speculative positions on rising commodity prices rose 9.3% in January, the fastest rate of increase since January 2006 and the highest net length (bullish positions) since November 2011. Indeed cotton isn’t the only commodity to have seen a rebound in prices during January. The Economist commodity price index shows prices have increased by 4.1% during January with industrial commodities rising by 11.3%.
Upside surprise to economic data since January supporting bullish sentiment
Since the start of 2012 there has been a raft of economic data releases from key cotton markets around the world. Broadly, data from Europe, China and particularly the US have surprised on the upside. In Europe, manufacturing PMI data point towards an improvement in economic conditions during January, even suggesting the Eurozone may have avoided recession during 2011Q4. Meanwhile in China, despite representing a slowdown from 9.1% GDP growth in 2011Q3, 8.9% GDP growth in 2011Q4 came 0.2% higher than analyst expectations. In the US the jobless rate fell to 8.3% in January (a 3 year low) while GDP growth came in at 2.8% in 2011Q4 up from 1.8% in 2011Q3. The Citigroup Economic Surprises Index for major economies which measures actual economic data versus consensus expectations rose by over 50% since the start of the year.
Chinese buying on the dips to fill reserve
China maintains a strategic reserve of cotton in order to keep its domestic textile mills operating. During the first half of 2010 those reserves reportedly dropped to low levels and ever since the Chinese have been buying cotton to gradually build those reserves back up. Estimates vary as to how much cotton they have bought with some market participants estimating that China has bought around 12 million bales and are likely to buy another 6-8 million bales over the next few months (over and above their current domestic needs) in order to rebuild their reserves. Recent market activity has suggested anything below $1 per lb has been met with Chinese buying. Once the reserves are fully replenished later in the first half of 2012 however, one of the key recent price supports may wane.
Drought in Texas set to continue to be supportive
The onset of la Niña has brought dryer than normal weather conditions to the crop producing regions of Northern and Southern America. In the US, the southern crop producing states have been particularly affected with drought conditions in cotton producing Texas currently described as extreme or exceptional. The latest seasonal assessment forecast from the US National Weather Service covering the period 2 February to 30 April 2012 expects drought conditions to persist over the southern states for the next 3 months. The current drought conditions and expectations of it continuing may have implications for seeding early next season and supplies thereafter.
Supply down but stocks forecast to be healthy this year and next
Latest data from the USDA estimates 2011/12 output at almost 123 million bales, up from 115 million bales in 2010/11 and a record annual output. Taken together with estimated consumption there is expected to be a surplus of 12.8 million bales in 2011/12, the last significant surplus being 12.4 million bales in 2004/05.
Using the same USDA data, the stock/use ratio (a key indicator of the availability of raw material) is estimated at 53%, up from 37% in 2009/10. The latest forecasts from the International Cotton Advisory Committee (ICAC), published early February also suggests the stocks/use ratio will be 53% in 2012/13, which effectively means that the world will effectively have half the world’s supply in store this year and next.
Price outlook
As described there are some bullish factors in the market, namely the drought in Texas, Chinese purchases, recent better than expected economic data and increased speculative activity. Nevertheless the market for cotton, other commodities and indeed other financial markets may have got ahead of themselves after being unduly pessimistic heading into the end of 2011 and it feels that the bullish factors are already known and priced in. Furthermore, the fundamental supply situation remains broadly plentiful going forward into 2012, even accounting for the potential for reduced acreage devoted to planting. Our central forecast for the next three months through to the end of April is for prices to continue to find a floor at around 95c per lb due to Chinese purchases initially before that price support wanes later in the outlook period. Indeed we expect speculative interest to also provide support to prices early in the outlook period but for disappointing economic data and better than expected supply data to weigh on the market towards the end of April. Our central forecast is for US cotton futures to average 97c per lb in February, averaging 99c per lb in March before falling to 95c per lb by the end of April. Looking further ahead we expect the fundamental supply/demand balance to weigh on prices further through the rest of 2012.
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