 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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| 2008/09 Old Crop Fundamentals and Caveats |
The old crop cotton supply/demand picture remains framed by USDA's June 10 World Agricultural Supply/Demand Estimates (WASDE) report. The June WASDE raised U.S. old crop exports by 200,000 bales, giving the same decline in old crop U.S. ending stocks (to 6.6 million bales). All things being equal, the small decrease in ending stocks should be neutral to slightly positive for nearby futures prices based on past revisions of monthly U.S. stocks-to-use forecasts. Practically speaking, it leaves old crop prices under the influence of outside markets and forces related to July09 cotton futures expiration.
The June WASDE estimates of old crop world ending stocks were a little over a million bales lower due to a little lower production and slightly increased use. The bottom line was a 1.3% decrease in projected world ending stocks-to-use to 55.3%. This is still an historically high level of stocks-to-use and not a fundamental signal for higher prices. While the A-Index of world prices has been rising in recent weeks, it is still below the upper-60s threshold which historically implies a positive LDP payment rate. Hence there is a 8.96 cent LDP in effect through July 2, 2009. As of June 1, the ICAC is currently forecasting the A-Index to average 60 cents for 2008-09, which implies that LDP payments will likely not rise during this marketing year, and could even erode more over the summer.
Caveat: Demand Uncertainty. Demand forces are relatively more important determinants of old crop fundamentals and prices. The two main elements of demand for U.S. cotton are domestic mill use and exports. Domestically, the June WASDE report did not adjust U.S. mill although it had been steadily lowered over in previous reports. The annualized rate of U.S. cotton consumption in May remained below 4 million bales per year. U.S. exports are generally more important source of demand as they represent 70% to 80% of total use of U.S. cotton. The week ending June 18, 2009 saw slightly higher export sales of 163,200 running bales of all cotton (i.e., upland and pima combined). Actual export shipments of prior sales were higher than the prior week at 284,900 running bales of all cotton. This is above the weekly level needed to meet USDA's current projected export level for 2008/09. At this rate we will likely meet and perhaps exceed USDA's current target of 12.7 million bales of exports for 2008/09. If we exceed this level, it will lower the projected carryover stocks for next year, and potentially make things that much tighter if the 2009 results in a short crop.
Old Crop Outlook Summary. The first half of 2009 showed more export demand than previously expected, which contributed to a draw down of U.S. old crop supplies. Of the ten million running bales of the 2008 cotton crop placed in the CCC loan, over 9.5 million have been redeemed. This is represented graphically by the vertical distance between the blue and red lines. With U.S. export sales slower and recent cotton trade generally slower, it is reasonable to expect a sideways trading pattern in cotton futures, with up/down volatility from outside forces, e.g., the variable U.S. dollar index.
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| 2009/10 Fundamentals, Outlook , and Caveats |
2009/10 Supply/Demand Projections . The USDA June WASDE report maintained USDA's earlier projected U.S. production of 13.25 million bales based on prospective plantings, five-year average (weighted by region) yield and abandonment to forecast 13.25 million bales. USDA lowered projected U.S. exports by 200,000 bales, perhaps assuming that any late increases in 2008/09 exports would come at the expense of next year. Thus the reduced carry-in and reduced exports resulted in no change to the projected 5.6 million bales of ending stocks in 2009/10. With no change from the previous month's projections, there was little fundamental reason for the market to react. This was also indicated when USDA held to its previous projection of a 48 to 60 cent/lb range in farm price for cotton. This implies a trading range of the Dec09 contract between the mid 50s and upper 60s.
World Ending Stocks and Price. The bottom line of the 2009/10 world projections was a drop from 57.8 million bales in 2008/09 to 56.5 million in 2009/10. While an improvement, by historical standards this doesn't suggest strongly rally in world prices. If the A-Index followed new crop NY futures into the upper 60s, then LDP payments would erode away to zero. However, if ICAC is correct with their lower forecast of the new crop A-Index between 41 to 58 cents, then LDP payments would remain positive.
Caveat: U.S. Supply Uncertainty. We are in the time of the year when new crop fundamentals are focused on supply uncertainty (e.g., soil moisture, prospective plantings and abandonment). Weather market concerns are relevant every year, but perhaps more so in 2009 given the likely distribution of U.S. cotton acres in currently dry and historically variable production regions like Texas.
South Texas (i.e., USDA NASS districts 8N, 8S, 9, 10N, and 10S) may have lost three quarters or more of its five year average production. Central Texas has been baking in heat and the northwestern regions are just getting started. I have been guessing that the abandonment percentage in USDA's new crop forecasts may be higher than the five year weighted average assumed by USDA. For Texas upland cotton, the abandonment rate (planted less harvested divided by planted) for 2004-2008 has been highly variable: 8.6% (2004), 5.9% (2005), 35.9% (2006), 4.1% (2007), and 35.0% (2008). The straight average of those numbers is 18%, which is what USDA has been assuming in it's weighted average regional abandonment calculation. If 2009 winds up as dry as it has started, the Texas abandonment percentage could be like 2006 or 2008 (or even 1998 when it was 42%). West Texas has seen scattered showers over the last few weeks, including widespread showers ten days ago and some additional scattered showers (averaging less han a half inch) over the weekend.
So perhaps the start of this season may be better than in 2006 or 2008, although there is still speculation about the demise of a relatively large chunk of dryland cotton in the Southern Plains. The abandonment that may result from this will not be reflected by tomorrow's planted acreage report.
For the week ending June 28, high pressure conditions over Texas led to reports of triple digit temperatures and with varying soil moisture (depending on whether they caught the previous week's rains). We'll have to see how this affects the crop condition ratings, which were mostly fair to good for the preceding week. Similarly, 70% of the U.S. cotton crop rated in either the "fair" to "good" category. There is still a lot of time left, so these ratings have little relevance at this point to the outcome of the U.S. crop.
The current soil moisture picture can be pictured with a couple of different tools. The U.S. Drought Monitor showed improvement in parts of the Panhandle, South Plains, and Rolling Plains, compared to the previous week. That being said, these southerly (dryland) portion of these regions remain in "abnormally dry" to "severe drought" classification, and the baking heat this week won't help any. Central and Southern Texas remain ground zero for Extreme/Exceptional drought. The current Keetch-Bynum Drought Index for June 28 shows the worsening conditions in the southeastern third of Texas, makes a clear distinction between the drier parts of the South Plains and Rolling Plains from the Panhandle and Red River region. The normal summer weather pattern for this time of year would project continued drying out (reflected by the Keetch-Bynum forecast for June 28).
Upcoming Reports. All eyes this week will be on Tuesday's USDA Planted Acreage report as a milestone in gauging U.S. crop supplies. However, as noted above, the planted acreage report does not account for the likely high abandonment of Texas cotton acres, so a lot of uncertainty remains. Even the August supply/demand report may inadequately measure the boll development on this spotty West Texas crop. So it may be mid-September before we have a statistically reliable picture of what is out there. This uncertainty may provide support for cotton prices in the form of a summertime risk premium. It may also lead to a potential explosion if the September report doesn't confirm the bales predicted by the August report. On the other hand, if we continue with spotty rains, and maybe get some late August rains (as happened in 2006), I am reminded of how much cotton can be unexpectedly made in September in West Texas under the right conditions.
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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.
Near Term Price Trends. For the week ending June 26, cotton futures first struggled, then rallied mid-week, and held on at week's end. The weakness early in the week was in the wake of poor economic outlook and a strong U.S. dollar. The dollar strength reversed on Tuesday. The mid-week recovery and final stalling all appeared to be technical in nature as the 50% retracement appeared to hold on Wednesday, leading to trading above predicted resistance levels which begat more buying on Wednesday/Thursday, albeit in light volume. Open interest has been noticeably dropping as well, which suggests that the fund sector is stepping out of the cotton futures market. The lack of "normal" speculative buying in the cotton market would take the wind out of the bullish argument.
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.) For example, the spechedge chart as of June 19 shows that the previous ten-week old net long position of trend-following speculators switched to net short. That is, last week's position of 679,100 more speculative long contracts than short contracts switched to 155,600 more short contracts than longs. This shows a decline in speculative longs, and also a drop in the total number of long/short positions (i.e., lower open interest). The implication is for less support for cotton prices from the fund sector.
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 information breaks out the Index Fund position separately from the hedge funds. (The index funds mostly practice a buy-and-hold strategy.) For example, the CFTC data chart show that while the net long index fund position (i.e., the blue bars) is still roughly level, the hedge fund position (i.e., the green bars) declined a bit, confirming the Spechedge pattern.
Certificated Stocks. 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. Last week's level of certificated stocks continued to grow to 425,607 bales as of June 26.
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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. In the current situation, most of the new crop supplies were placed into the CCC loan. Most of that has since been redeemed against merchant sales. However, growers with any old crop cotton should continue to watch for opportunities to sell their equities in those opportunities when the spread between the AWP and NY futures is 12+ cents. That's when cotton merchants are reportedly able to afford to redeem cotton from the loan. CCC equity trading in southwestern markets was reportedly inactive last week.
For the 2009 crop, I am expecting a limited trading pattern for Dec'09 futures (similar to 2005 and 2006). The recent rally has left behind strategies of shopping for call options (i.e., the relevant rally has already happened -- I hope some folks bought some cheap call options early in 2009). Now, if weather and market conditions create enough speculative buzz to push Dec09 back into the lower 60s, I would be be shopping for put options at that point (with the expectation that prices would settle back into the mid-to-upper 50s range after September, as the did in 2005 and 2006). |
| 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. 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 last example is December 2007 when more volatile and higher prices provided more opportunities to set a flexible floor using 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/ .
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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