 Cost
Expectations |
A marketing plan is a contingency plan of actions that you will take in various possible, but ultimately uncertain, market situations. Developing and implementing a marketing plan begins with an 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 Fundamental Analysis and Forecast |
The supply/demand picture for 2008/09 is currently framed by USDA's August 12 World Agricultural Supply/Demand Estimates (WASDE) report. The latter applied the June 30 acreage forecast, 15% abandonment, and an 842 lb yield to forecast 13.77 million bales of U.S. all cotton production. The bottom line of the August forecast is a forecast of only 4.6 million bales of 2008/09 ending stocks.
Fundamentally, the longer term outlook for 2008/09 is supportive of new crop cotton futures prices because the possibility remains for a strong reduction in ending stocks under a wide range of possible yield and planted acreage outcomes. This outlook gives the supply/demand rationale for a trading range for new crop cotton futures from its current level to about the mid 80s. As we are carrying in a very large amount of old crop supplies, this will pressure the nearby Oct08 and Dec08 prices to the lower end of this range. This U.S. price forecast implies a somewhat higher range of world prices, which jibes with the International Cotton Advisory Committee's forecast of a 83 cent season average A-Index for 2008/09. (As before, this in turn implies a zero LDP payment rate.)
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| 2008/09 Caveats |
Beginning Stocks . The 2007/08 marketing year is now gone, but not forgotten. What I mean is that USDA's August 12 WASDE report maintained the previous estimate of 13.9 million bales of exports and 10.2 million bales of ending stocks for 2007/08. These numbers will likely see some tinkering in subsequent reports, with 2007/08 carryout being raised a few hundred thousand bales in excess of 10.2 million bales (i.e., the amount by which USDA's target for 2007/08 exports was missed). This leaves a very large amount of cotton to carry over into the new marketing year that began August 1, 2008. Fundamentally, this gives a negative outlook for near term prices, as suggested by past upward revisions in monthly stocks-to-use forecasts.
Demand Uncertainty. The two main elements of demand for U.S. cotton are domestic mill use (generally down-trending) and exports. The latter is generally more important as it represents 70% to 80% of total use of U.S. cotton. The week ending August 7 showed strong export sales of 399,600 running bales of all cotton (i.e., upland and pima combined). Export shipments of 224,100 running bales were just under the weekly level needed to meet USDA's project export level for 2008/09.
Supply Uncertainty. Even though the August report is an important benchmark, it often raises as many questions as it does answers. Such questions are being asked by West Texas industry representatives about whether USDA's yield/production estimate for northwest Texas is too high -- i.e., whether this crop might get smaller. Recent history shows about an average 8% adjustment in USDA's U.S. cotton August production projection over the succeeding months. Over the last ten years, this includes 5% to 10% downward revisions in dry years when "small crops got smaller", as well as 10% to 15% upward revisions when "big crops got bigger".
Given the nature of relatively late maturing crops in West Texas, there is still a lot of time for weather, crop/harvest conditions, and the other uncertainties to influence the U.S. cotton supply. And no more so than this year with the majority of U.S. acreage in Texas. Therefore the next (September 12) USDA projection of U.S. yield will be greatly anticipated as it will better measure the West Texas yield potential as well as crop maturation/harvest conditions further east.
The U.S. Drought Monitor as of August 12 still shows non-drought "islands" in the southern High Plains and Rio Grande Valley regions of Texas. The rest of the U.S. cotton belt remains in some stage of drought. The cumulative weekly precipitation map through Sunday August 17 reflects scattered showers and significant looking accumulations (i.e., remember, this is radar imagery) across the cotton belt from the southern High Plains eastward.
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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 August 15, cotton futures prices traded sharply lower due to reported fund liquidation of commodities in the face of a a continued strengthening dollar. Selling by index funds (who only hold long positions) apparently begat more selling by hedge funds (who also take short speculative positions), so the new net short spechedge position may get larger.
Spechedge Numbers. Since June of 2007 the net position of speculative traders that swing either long or short (i.e., hedge funds and small speculators) has been net long. Over these twelve months there have been three major price rallies, mostly attributed to this speculative buying on top of index fund buying (which isn't reflected in the spechedge chart). However, from February's peak of 7,245,800 bales worth of net long futures positions, the net speculative long position (reflecting the "Customers Only" category) has switched to net short. What this shows is a general decline in speculative longs among those speculators that can swing either long or short. The remaining speculative longs are largely comprised of the index funds.
Certificated (i.e., deliverable) stocks declined 1.65 million bales as of August 14. Certificated stocks represent merchant inventory that is in position to be delivered against short futures contract positions. A high level of certificated stocks enhances the possibility of delivery (which ordinarily would reinforce the economic linkage between futures and cash markets, i.e., by driving futures prices down towards cash prices). The perfect storm version of this would be if large merchants coupled a large chunk of these deliverable stocks with short Dec08 futures positions to create a shortage of offsetting buyers prior to Dec08's first notice day, i.e., when the index funds and other long speculators want to roll their long positions forward. That scenario could create frantic competition to offer Dec08 futures at lower and lower selling prices, and drive it down towards the level of cash prices. |
| 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.
Given the situation in early March, it may some time before many merchants are in a position to offer forward contracts. Forward pricing opportunities may be implemented with options (e.g., buying put options on un-priced expected production), but only after this market calms down.
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| 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 start in February 2009 in the San Angelo area. 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. |
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