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The cotton market has come full circle over the past two seasons. Only recently it was a market characterized by surplus and high inventory levels; but is now one moving toward tightness as acreage shifts into more profitable competing crops such as corn, rice, soybeans and wheat. With the plantings of the 2008/2009 crop just beginning in S. Texas, the market has attempted to catch up to the strength in other crops in order to buy back critically needed acreage. Despite the recent price strength, the question will continue to arise as to whether it is enough to ration demand and encourage production, not only in the 2008/2009 crop year but successive crop years as well.

If you cannot view the Cotton Monthly chart, go here.

The cotton price chart above shows demonstrably the boom and bust that has characterized cotton prices with swings of 50 cents not uncommon. Currently, with prices near the 72.00 cent area we are back toward the middle of the trading range. It needs to be recognized that despite the relatively tepid price for cotton currently, its relationship to soybeans, corn and rice has weakened dramatically and is near record lows. With the other commodity markets moving toward record highs, the potential for cotton prices also appears to be on the upside as supplies fall steadily short of demand.

US Cotton Overview

If you cannot view the Cotton Overview chart, go here.

The US cotton supply/demand situation has grown tighter during the 2007/2008 crop year. A sharp decline in planted acreage of 29% pushed production down to 19.0 million bales compared to over 21.6 mb in 2006/2007. Yields increased sharply to 871 pounds per acre versus 814 pounds per acre the previous year on favorable weather, and as greater amounts of genetically modified seed were utilized. Although domestic usage rates continued to fall reflecting the high textile import levels, higher exports totaling 15.7 million bales compared to 13.0 mb in the prior year more than compensated for the decline in domestic mill use. Subsequently stocks declined to a more comfortable level of 8.2 million bales compared to 9.5 million bales in the previous season, or 40.4% of usage.

If you cannot view the Cotton Planted Acreage chart, go here.

The 2008/2009 season appears to have even more exciting metrics. With a bushel of wheat trading at a record high ratio to a pound of cotton of 15:1 and soybeans near record highs at 20:1, the incentive to plant competing crops has been great. The focus for new crop prospects will be upon the March 30 planting intentions report. Current forecasts suggest the potential for planted acreage between 9.2-9.5 million acres. Assuming normal abandonment, this level of acreage would lead to production reaching only14.9 mb. At this level of output, we are forecasting a usage rate of 18.9 mb compared to 19.5 forecasts for 2007/2008. Stocks subsequently would fall to 5.6 mb or 29.6% of anticipated usage.

If you cannot view the US Seasonal Drought Outlook map, go here.

Of particular importance to the production forecast is the Texas weather outlook, since that area accounts for over 35% of total U.S. production. Although cotton is seen as a semi arid crop, it needs moisture to properly germinate. Currently rains in the Southern Plains of Texas and Rio Grande Valley have been lacking as the following NOAA weather map suggests. Drought is expected to persist in the Southeastern U.S., a key cotton production area as well.

World Supply/Demand Outlook

If you cannot view the World Cotton Supply and Use chart, go here.

For 2007/2008, upward revisions in the February supply/demand report by the USDA in Chinese and Indian production led to world production reaching as high as 126.32 million bales, with foreign production set at 100.2 mb, basically unchanged from a year ago. China remains the world’s largest producer at 34.5 mb while India is projected to produce 24.5 mb. These areas, which continue to benefit from buoyant economic growth, are also the two largest world consumers of cotton. In China, it is estimated that total usage will reach 54 million bales, or 42% of global usage. In India, usage is forecast to reach 18.7 mb. Given the prevailing forecasts, a decline in inventory levels of only 3.4 million bales is projected for 2007/2008. However in China, stocks are forecast to decline sharply, falling 12.3 million bales to 17.14 million bales.

For 2008/2009, we anticipate production levels to tentatively reach 123.8 million bales. Some movement of acreage from cotton to grains could provide the basis for a reduction in Chinese production to 33.5 million bales, but the need to support textile manufacturing will limit the decline. Domestic mill use, primarily due to an expansion in China, will likely increase by 2% to 129 million bales. Ending stocks are forecast to total 48.5 million bales, a decline of 8.8 million bales. Over half of the decline in inventories is expected to be attributable to China, where stocks as a percent of usage will fall to as low as 21.8%. On a world basis stocks to usage is anticipated to fall to 37.6%.

Price Outlook

If you cannot view the Dec08 Cotton chart, go here.

The steady decline in ending inventory levels and uncertainty with respect to early development of the Texas crop raises the upside potential for cotton values. Although to some extent the lower crop has been priced in for 2008/2009 season as the December trades above the 80.00 levels, we still feel that the stock decline will not bottom out until the 2009/2010 crop year at the earliest, lending a longer term upside bias. In addition, the maintenance of a high petroleum price will underpin man made fibers, keeping cotton competitive. Subsequently we favor the long side of Dec on pullbacks toward the 76.50 level risking 75.30 with an objective of 85-86 near term. Longer term a price near the 1.10-1.20 area cannot be ruled out.

Feel free to contact me at (877) 377-7931 or at Stephen.Platt@archerfinancials.com with any questions regarding this story, for a market update, or for any other issues you may have in relation to the commodity markets.

To obtain additional Research or receive a complimentary trial, contact the authors:
Steve Platt: Stephen.Platt@archerfinancials.com
Mike McElroy: Mike.McElroy@Archerfinancials.com
877-377-7931

The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation. The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition. The information and comments contained herein is provided by ADM Investor Services, Inc. and not Archer Daniels Midland Company. Copyright © ADM Investor Services, Inc.

Charts Courtesy of DTN/NOAA