 Cost
Expectations |
A marketing plan is a contingency plan of actions that a grower would take in various possible, but ultimately uncertain, market situations. Developing and implementing a marketing plan begins with an updated estimate of expected production costs. Without
accurate farm-specific cost information, it is impossible to set meaningful pricing
goals to cover your production costs. Texas cotton growers have a number of available
sources of information and programs to help them figure
their production costs as accurately and completely as possible.
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| 2009/10 Fundamentals and Outlook |
2009/10 U.S. Supply/Demand Projections . The November WASDE report made few albeit substantial adjustments to the Foreign and U.S. cotton supply and demand forecasts. Compared to their October report, USDA decreased 2009/10 U.S. production by 500,000 bales. Carry-in, domestic use, and export forecasts were unchanged, so the the bottom line was a 500,000 bale decrease in projected ending stocks for 2009/10 compared to the October report. This actually represents a small decrease in stocks/use over the 2008/09 marketing year.) Based on history, this represents a moderate supply/demand rationale for higher prices, and could explains some of the recent price rally. USDA's cash price forecast was shifted upwards three cents to a 52--60 cent range.
World Ending Stocks and Price. The November WASDE report reduced USDA's forecast of Chinese cotton production by one million bales (for the second month in a row). Together with the U.S. reduction, this outweighed small production increases in Pakistan and other countries for a million bale reduction in world production. Coupled with an increase in foreign mill use, world ending stocks were lowered almost 2.5 million bales to 53.72 million bales. The bottom line was a decline in world stocks-to-use from 55.8% to 47.3%. History suggests such a revision would have a moderately positive effect on world prices. With an A-Index in the upper 60 cent range, the LDP payments has eroded away to zero. This may continue for a while, and the trend suggests that the 2009/10 LDP payments may average out to a small, negligible, or zero value. This is what ICAC is suggesting by raising their 2009/10 A-Index forecast range of 59 to 76 cents, with a season average of 67 cents.
Fundamental Outlook. Compared to the October forecast, both the world and U.S. supply/demand situation suggests that the picture has shifted somewhat. Weaker prices tend to prevail in the harvest season when carryover stocks are increasing or stable. Level to slightly higher prices have been observed during harvest times in years when stocks are declining relative to the previous year. Since futures markets are anticipatory by nature, some of the market rally this fall can be explained by changing supply/demand expectations. Since the picture is now tighter than it was, prices might be more sensitive to unanticipated future developments, particularly changes in demand expectations.
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| 2009/10 Caveats |
Demand Uncertainty. The two main elements of demand for U.S. cotton are domestic mill use and exports. Domestically, the annualized rate of U.S. consumption in September was U.S. 2.9 million statistical bales. This is a continuation of the general downtrend. The USDA reflected the trend in the October WASDE report by lowering 2009/10 U.S. domestic use to 3.4 million bales. They did not make any further adjustments in the November report. Exports are generally more important source of demand as they represent 70% to 80% of total use of U.S. cotton. The week ending November 12, 2009 showed higher export sales at 268,100 running bales of U.S. all cotton (i.e., upland and pima combined). The pima portion of this was again substantial at 32,400 running bales. Almost 60% of these export sales were to China. Export shipments of all cotton were lower at 124,300 running bales, which is below the weekly level needed to meet USDA's September target of 10.5 million bales of exports for 2009/10.
Supply Uncertainty. Historically, when crop estimates have been revised downward, the initial USDA production forecast in August declined from 2% to 10% over the next 11 months. Right now the current November production estimate is 5% lower than the original August forecast.
Crop progress/condition. The USDA chart of Texas cotton progress for the week ending November 15 showed a reversal/slide in the good/excellent rating of the Texas crop compared to the previous week. The U.S. version of this graph shows the same pattern, although the U.S. rating for 2009 is decidedly below that for 2008. The Texas cotton crop remains collectively rated as mostly fair to good statewide as of November 15. The mid-week Texas weather summary (as of November 17) noted the effects of generally mild and warmer weather which helped the progress of cotton harvesting in the northern portions of the State.
The most recent USDA-NASS Crop Progress report showed continued harvest progress in the MidSouth. Arkansas has moved from only 19% harvested to 71% harvested between November 1 and November 15. It is still behind its average 98% harvested level, but it is making progress. Similarly over the past two weeks, Louisiana increased from 34% harvested to 89%, Mississippi rose from 14% to 85%, and Missouri's gain was from 17% to 69%.
In the November report, USDA-NASS cut expected production a little in Texas, i.e., trimming statewide average yield by 14 lbs/acre, which adds up to a little over 100,000 fewer bales. Perhaps this will be the bulk of it, but since the crop is relatively late, I wouldn't be surprised by a little more marginal adjusting in the next couple of reports. NASS also made a big cut in forecasted MidSouth Production. About 200,000 bales were trimmed in forecasted production from Arkansas, Louisiana, and Mississippi, with the Arkansas feeling 70% of that. Missouri also took a 183 lb/acre cut in projected yield, which adds up to a little under 100,000 bales. Thus, these Delta states and Texas account for 80% of the 500,000 bale cut in forecasted U.S. production. Is there room for more adjusting? Given the lateness of the crop, the answer is probably yes, but probably not in such large amounts.
Moisture Situation/Outlook. Texas and the Delta saw only limited precipitation for most of the week ending November 20. The 7-day cumulative rainfall map through early Friday indicates some accumulations from a cool front that passed over late Thursday/early Friday (with more rain likely late Friday and early Saturday). The Keetch-Bynum Drought Index for November 19 still shows the very moist conditions in the Panhandle and Central, Southeast, and Northeast Texas. Compared to the previous several weeks, the U.S. Drought Monitor for November 17 was basically the same, other than some very slight improvement in the Carolinas and northern Florida.
In terms of foreign new crop supplies, as of this writing there has been little new public information out of China since the earlier reports of rainy and cold weather during their late harvest period. In India, Hurricane Phyan's impact last week did not appear to extend over much of India's cotton producing regions. At any rate, the country's cotton industry was not highlighted in the damage assessment.
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| Technical Analysis and Nearby Futures Prices |
Technical analysis involves predicting price movements based on earlier price patterns, calculated support/resistance levels, moving averages, retracements, and other indicators. Technical analysis may have implications for hedgers even though their market entry/exit isn't as frequent as professional traders.
Weekly Price Pattern . The week ending November 20 saw cotton futures trade mostly higher in a fairly narrow band. Cotton futures settled up four day out of five, with the most active Mar10 contract settling up 111 points on Friday at 74.08. The Dec10 contract settled up 87 points at 77.60. Higher cotton futures were again generally associated with declines in the U.S. dollar index, and vice versa. This inverse dollar-commodity relationship did not apply to some other ag futures markets this week, and it also broke down Friday as cotton futures rallied regardless of strength in the IDX.
Net Position of Speculators. The speculative fund sector has had a major influence on cotton and other commodity markets in recent years. There are two sources of information that give snapshots of the position of speculators in the market. The first is the ICE futures exchange Spechedge report, which is released early in the week, and reflects the net position of "hedge fund" type speculators as of the previous Friday. (Hedge funds are trend followers who buy a rising trend and sell a falling trend, using moving averages and other technical indicators.) The spechedge chart as of November 13 the 21st straight week of a net long position of trend-following speculators. That is, on November 13 the excess of longs over shorts was 3.5 million bales worth of contracts. This net long position is just slightly larger than the previous week due to slight decreases in long positions plus larger decreases in short positions.
Another closely watched source of similar information is the CFTC's Commitment of Traders report, which is released on Friday's and reflects the previous Tuesday's net position. Note that the CFTC data is reported in contracts (roughly 100 bales per contract). The Commitment of Traders picture as of Tuesday November 11 showed small declines in both the index trader position (generally net long) and the hedge fund position (which happens to be net long).
Certificated Stocks. The current level of certificated stocks has no particular price implication. (Much higher levels could have a price depressing effect near delivery times.) Certificated stocks represent mostly merchant inventory that is in position to be delivered against short futures contract positions. The level of certificated stocks in delivery point warehouses is reported daily by the ICE. The previous week's level of certificated stocks decreased to 439,725 bales as of November 19.
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| Marketing
Strategies |
A marketing plan is a price contingency plan of actions that
a grower/hedger will take in various possible, but ultimately uncertain,
future market situations. The only thing that is certain is what you can pay right now to reduce your risk. It is basically an insurance question. A marketing plan can include many elements,
probably in combination with each other. These could include basic
tactics like forward contracting, selling
at harvest, marketing pools, and the USDA loan program. Hedging with futures and options can complement or substitute for these basic tactics.
It is uncertain how long the current sideways/upwards pattern of nearby futures will continue. If a grower's cotton already has a floor from participating in a pool or directly in the CCC loan, consider the likely impact of a shortage of good grades. My guess would be that the better qualities will be bought after harvest or redeemed sooner out of the CCC loan. The lower quality bales from the 2009 crop may have to wait in the loan -- wait for lower prices which could be here by next summer. But before then, we could still see some upside volatility in the spring-time contracts, especially if China begins importing a lot more to beef up their reserve stocks.
From a price standpoint, Dec10 cotton futures are still trading above the mid-70s. These are increasing desirable levels for forward pricing-- the question is
how. When Dec10 first went over 70 cents (in July) foreign growths were reportedly being hedged at that level to "buy acres". Since then, Dec10 has risen all the way to 77 cents as of this week. Why would anybody not expect more 2010 cotton acreage in response to this? And that could mean an abundant supply of cotton next year (to be confirmed by the March and June acreage reports as well as foreign forecasts). Match that up to a fuzzy demand picture, and I could envision an eventual price decline for Dec10 cotton futures. Perhaps a similar pattern as in 03/04 when high wintertime prices induced a lot of acres and the December 2004 futures contract had a major decline in mid-2004. Now to be fair, there are some recent projections of recovering demand and declining world production. To the extent this is accurate in 2010, it dampens the bearish argument I am making above.
How can a grower lock in higher prices now? I would not recommend selling futures in this world of greater volatility and greater margin/liquidity risk. Especially not after the industry's experience in March 2008. There continue to be various forward contract offerings here in Texas for next year. Some of these forward contracts pencil out into grower cash prices between 65 and 70 cents, depending on the contract and the grade.
It may still be possible for a grower to create a similar net price (subject to basis risk) using bear put spreads or "three way" spreads around a core put position on Dec10. For example, on Friday a 75 cent Dec10 put cost just over six cents a pound (equals roughly $3,000 per 100 bales covered). Assuming a six cent basis and the cost of the premium, that locks in a flexible floor of 63 cents (i.e., still leaving upside potential). This position could be enriched a little (with a little added risk) by also selling a 60 cent Dec10 put (which traded Friday for 124 points) reducing the net cost of the core put position to about 4.75 cents. It could be cheapened up more (with more risk) by selling a 65 cent Dec 10 instead (which traded on Friday for 233 points, reducing the core put position to 3.66 cents). I would recommend that growers be shopping for these sorts of alternatives if they haven't already contracted with a merchant or a marketing pool.
And lastly, if the Dec10 stays high through January-February, it will result in a high Crop Revenue Coverage (CRC) base price for central and northern Texas counties. (The CRC calculation for South Texas counties is based on the Oct10 contract settlements between December 15 and January 14.) Having a high CRC base price is analogous to having downside price protection, coupled with yield insurance. I would recommend that growers be watching for these calculated base prices and weighing them against other risk reducing alternatives like contracting or option hedging. |
| Historical Examples Emphasizing The Flexibility of Options Strategies |
Recent history
provides five examples of how different price patterns can be
approached with the flexibility offered by options strategies.
The first is December 2003 whose unexpected
late-season price surge highlights the need for upside price flexibility
in your marketing strategy. The second example highlights the need
for a price floor when you have a reasonable expectation of a major
price decline, as in early December 2004. For what it's worth, I think 2004 is the relevant example to consider looking ahead to the 2010 crop. The
third and fourth examples are from December 2005 and December 2006 when
prices traded in a narrow band below most growers' costs of production.
In this situation, insuring a meaningful price floor using put
options would have been more expensive, so various spread strategies
could have been employed to finance the core put option strategy. The December 2007 contract shows how more volatile and higher prices provided more opportunities to set a flexible floor using options. The December 2008 contract provides an extreme picture of volatility and potential option hedging (with some caveats about accessing and/or affording the options).
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| Educational
Resources |
The Texas AgriLife Extension Service offers a number of resources on marketing
and risk management. The pre-plant educational meetings offered
by county extension agents often include market outlook information.
Extension agricultural economists regularly conduct half-day or
one-day trainings introducing the topic of hedging with futures
and options. To have one in your area, contact your county agent.
In addition, Extension Economists periodically offer Master
Marketer workshops, which involve 64 hours of training aimed
at developing a comprehensive marketing plan. The next Master Marketer workshop will be held in Amarillo. The leveling workshop will kick off the program on Tuesday January 12, 2010 followed by Session I (Jan. 13-14), Session II (Jan. 27-28), Session III (Feb. 10-11) and Session IV (Feb. 24-25). (That's right, it's eight days worth of training.) Registration information will be available at http://mastermarketer.tamu.edu/ .
One thing we always do at Master Marketer is conduct a hands-on trading game for cotton and grains. This year we are offering one-day Cotton Risk Management Workshops that provide this kind of learning experience, along with current cotton/grain market outlook and a discussion of current crop insurance issues. We have tentatively scheduled several of these workshops for January 26th (Lamb County, TX -- contact Todd Beyers, 806-385-4222), January 29th (Bailey County, TX -- contact Curtis Preston, 806-272-4583), and February 23rd (Lubbock, contact Jackie Smith, 806-746-6101). Registration will be $50 per person, and registration information will be forthcoming.
Additional one or
two-day Advanced
Topic Series workshops are offered annually to supplement Master
Marketer. Extension economists and county agents are involved in
a number of marketing
clubs which provide growers an opportunity for more regular
interaction and discussion about marketing. We facilitate the monthly Ag
Market Network activity which connects growers and marketing
clubs with panels of knowledgeable analysts. To support all these
efforts, we also have an extensive on-line
library of short articles about various topics related to marketing
and risk management. A good, comprehensive and cotton-focused on-line
bulletin about the cotton futures market is available courtesy
of my colleague Blake Bennett and Cotton Incorporated. A paper about Texas cotton transportation and logistics compares current cotton flow data with information from the 1980s and 1990s. Lastly, with permission from the good folks at Cotton Outlook, I am reprinting here a descriptive, background article entitled Trends and Prospects for Texas Cotton.
And for a timely, ground-truthed view of the cotton world from the Lubbock area, my Extension colleague Jay Yates publishes the weekly South Plains Cotton Update. |
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