After cotton rose in 2011 to historic highs not seen since the Civil War, production has caught up to demand this year.
Unlike the prior two years, cotton prices so far in 2012 have been relatively calm, falling roughly 10 percent since the beginning of the year. While a 10 percent drop should be of concern, in the context of the last two years, cotton prices have found fairly stable ground above and below the $1 mark.
However, a surge in production in reaction to historically high prices in 2010 could weigh on prices for the rest of the year, another divergence from recent price history.
In July 2010, cotton prices were trading at 78 cents a pound. Prices exploded during the next eight months to a high of $2.27 a pound, an increase of almost 300 percent. These lofty prices had not been seen since the American Civil War.
Back in the 1860s, as is the case today, America was the world’s largest cotton exporter. The Confederate states initiated a cotton embargo on Great Britain, their largest buyer, in an effort to coerce the British into revoking their official position of neutrality on the war between the states. Cotton prices shot up from 10 cents a pound in 1860 to $1.90 a pound by 1864. But because of the embargo, and a Union blockade of most commerce, Confederate producers were unable to take advantage of the price spike they had created.
In 2010, a perfect constellation of events fueled another historic price rise. Gradually tightening stocks, an unexpected freeze in China’s cotton producing areas, a historic flood in Pakistan and a ban on exports from India all caught buyers off guard.
On the demand side of the equation, retailers had run down any excess inventory and were anxious to refill depleted supply chains. By July 2011, ending stocks had fallen to 47 million bales, representing a scarce 40 percent of use.
Following The Pattern
Higher prices in early 2011 did what high prices always do: They encouraged more production and reduced demand, some of the reduction in demand coming from cheaper alternatives such as polyester. The rally ended in March 2011, and prices have given back almost all their gains. Prices are currently trading at around 90 cents a pound.
Total world production of cotton for the 2011/2012 season (August/July) is estimated at 123 million bales, which weigh 480 pounds each. That’s a record high. With record production and flat consumption, ending stocks by August 2012 are expected to be 66.0 million bales, another record high. Much of the stocks, however, are in Chinese state reserves and few are found in the U.S. These ending stocks would represent 61 percent of use, a level not seen since 1999, when prices were trading at around 50 cents a pound.
The cotton plant is native to tropical and subtropical regions. It is almost unique in that it produces not only cotton fiber for the production of fabric, but also produces cotton seeds that are pressed into oil for use in foods and cosmetics as well as cotton meal for animal feed and fertilizers.
Approximately 80 countries produce cotton. The biggest producers — China, India, the U.S. and Pakistan — produce about 70 percent of the world’s cotton. The largest consumers (millers) of cotton are China, India, Pakistan and Turkey, which account for about 65 percent of world use.
U.S. domestic cotton is grown in 17 southern states, from Virginia down to Georgia and across the country to California. Texas is by far the largest producer, accounting for 20-30 percent of total domestic production.
Domestic cotton production and prices are heavily influenced by federally administered crop programs including, but not limited to, the 2008 Farm Act. Qualifying cotton producers are eligible for direct payments and loan subsidies, among many other benefits. The benefits and subsidies have been very generous. From 2000 to 2010, subsidies averaged $3.5 billion annually, while the harvest time value of domestic production averaged only $4.3 billion.
Since 2002, Brazil has been challenging the U.S. cotton program as a violation of several WTO trade commitments, and has won favorable judgments on several issues. Congress has yet to deal with the changes required to bring the program into compliance with WTO rulings.
The ICE Futures Cotton #2 (CT) contract is the benchmark for cotton prices. One contract is 50,000 pounds net weight. Minimum price fluctuations are 1/100th of a cent, or $5.00 a contract. Only cotton of U.S. origin is deliverable. There are two delivery points in Texas, and one each in Louisiana, Tennessee and South Carolina.
The current open interest in the Cotton #2 is 183,000 lots. Daily volumes typically average 20,000 to 30,000 lots. Presently, the market configuration is mostly flat. According to the last Commitment of Traders report, managed money operators were net short around 9,000 contracts.
There are two ETFs available: The iPath Dow Jones-UBS Cotton Total Return Sub Index (NYSE Arca: BAL), down 0.34 percent YTD; and the iPath Pure Beta Cotton (NYSE Arca: CTNN), down 2.40 percent YTD. Both are futures based.
Given the projected return to substantial ending stocks, many cotton traders expect any rally in cotton prices to be short lived. Managed money operators have already established a short position in the expectation of even lower prices.