U.S. and World Cotton Economic Outlook

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Dr. Gary Adams, Vice President, Economics and Policy Analysis
National Cotton Council
 
January 6, 2004
 
Nashville, TN
 
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U.S. and World Cotton Economic Outlook - Mr. Chairman, thank you for the opportunity to address the Board regarding the economic outlook for U.S. cotton. Let’s begin with a brief overview of the general economy.

Real GDP – The "jobless recovery" continues for the U.S. economy, albeit at a less-than-impressive rate. Preliminary estimates for the second quarter of 2003 put growth at 2.4%. This comes on the heels of two quarters of sub-2% growth and was above expectations of most analysts. However, looking a bit closer, we find that defense spending accounted for 1.7of the 2.4% growth. Consumer spending also continues to be a contributing factor.

Civilian Unemployment Rate – Despite the recent growth in the economy, unemployment has continued to inch upward, rising above 6% in recent months. Manufacturing continues to bear the brunt of the decline with more than 2.5 million lost jobs since the summer of 2000. Since the mid-1990’s, ATMI reports that more than 200 thousand textile jobs have disappeared – that’s a decline of roughly one-third.

CPI, Apparel – There is increasing attention given to the possibility of price deflation. The lack of pricing power due to competition from surging imports remains a problem for the manufacturing sector. The CPI for apparel provides a clear illustration with declines in excess of 10% from the late 1990’s. The only recourse is to cut costs by reducing employment. The drop in output prices also provides a dampening effect on the ability of raw cotton prices to increase.

U.S. Planted Area – Now, let’s turn our attention to the cotton market, and specifically, U.S. cotton supplies. In the August Crop Production, USDA puts 2003 cotton area at 13.6 million acres, down from 13.96 million in 2002. The Southeast accounts for the majority of the decline in upland area with a 10% reduction. The Mid-south and Southwest are roughly unchanged from last year, while upland area in the West is up 9%. ELS acreage is down sharply from the 2002 level.

U.S. Cotton Supply (1) – The August crop report represents the first survey-based estimates for the ’03 crop. Based on surveys conducted from July 25 to August 6, the US average cotton yield is projected to be 667 pounds per acre. This is 2 pounds above the 2002 level and 19 pounds better than the 5-year average. USDA currently puts abandonment of the 2003 US crop at 9.7%, consistent with the 10-year average but below the 5-year average of 13.7%. The result is a cotton crop of 17.1 million bales.

In general, yield potential in many areas of the Cotton Belt still looks reasonably good. However, the lateness and uneven development of the crop is a problem. Also, the Northern High Plains of Texas remain a concern as hot, dry conditions persist. Looking at the recent track record of the August report, it has tended to over-estimate the final size of the crop rather than underestimate it. Since 1990, the August estimate has exceeded USDA’s final cotton production by an average of approximately 600 thousand bales.

U.S. Cotton Supply (2) –Looking at total supplies, a crop of 17.1 million bales, together with beginning stocks, gives total supplies of 22.7 million bales, below either of the past two years.

U.S. Retail Cotton Consumption – In terms of expectations for cotton demand, we’ll first focus on the U.S. market. Retail consumption accounts for cotton spun in the U.S., as well as cotton consumed through textile imports. After a decline in 2001, consumption rebounded in 2002, with monthly numbers between 1.6 and 2 million-bale equivalents. For 2003, the numbers suggest that the retail market is continuing to outpace last year’s numbers. Through the first 5 months, retail consumption exceeded last year’s pace by an average of 170 thousand bales per month, although the gap was noticeably smaller in May. Based on these numbers, a retail market of 22 million bales seems reasonable – this compares to just under 21 million bales last year.

Net Imports of Cotton Textiles – However, the growth in consumption has been satisfied by imported products. Through May, imports were exceeding last year’s numbers by 180 thousand bales per month, and thinking back to the previous slide, retail consumption was up by only 170 thousand bales. Imports from most countries are above last year’s level, with Mexico being a notable exception. Imports from China are running 40% above year-ago levels.

U.S. Cotton Mill Use – The flood of imports continues to decimate the domestic textile industry. Mill use is now expected to fall to 6.6 million bales for the ’03 marketing year, down 700 thousand bales from ’02. Based on recent months, the estimate appears to be realistic.

Foreign Cotton Production and Use – With the decline in mill use, U.S. raw cotton has become increasingly dependent on exports. As a result, shifts in global supply and demand are particularly important to the U.S. market. USDA has put production outside of the US at 78 million bales, up 8 million from last year. China accounts for more than half of the rebound with India and Pakistan also recovering. Both Cotton Outlook and ICAC are roughly 1 million bales lower for the ’03 crop.

Cotton consumption is expected to continue to increase but at a slower rate than in the past 2 years with prices higher levels than observed in either 2001 or 2002. China accounts for the majority of growth. The cotton deficit for ’03 falls to 14 million bales, down from 20 million in the previous marketing year.

U.S. Cotton Exports – Assuming that only a portion of the deficit is satisfied by reducing stocks, the potential exists for U.S. exports to remain at levels comparable to last year’s number. If we attain USDA’s estimate of 11.8 million bales, then exports will be roughly 70% of this year’s crop. With a crop of approximately 17 million bales and mill use of about 6.5 million, then any exports above 10.5 million bales will reduce stocks for the ’03 marketing year.

World Cotton Ending Stocks – Whether it’s USDA, ICAC, Cotton Outlook, or the Council’s outlook from Annual Meeting, a common theme is declining stocks for the current marketing year. In all cases, a decline of 3-4 million bales is expected. In USDA’s most recent numbers, stocks would fall to 34.3 million bales by July 31, ’04. If realized, it would be the lowest stocks since the end of the ’94 crop year. Historically, when stocks fall to these levels, world prices have been substantially higher than current levels. However, there are other factors that must be considered. World stocks peaked in 1998 with a significant stock accumulation in China. Since that time, Chinese stocks have declined while stocks outside of China increased through 2001. Now, those stocks are expected to decline for the second straight year.

"A" Index, Spot 4134 and USNE – So, what have been the implications for prices? Since March, prices have moved in a sideways direction, although there’s been some weakness since the crop report. So, where do we go from here?

Cotton Stocks/Use (World less China) – One of the indicators of possible price movements is cotton stocks/use levels, specifically those outside of China. Cotton stocks/use, measured on the left-hand axis, rose between 1994 and 2001, peaking at 50%. In ’02, it fell to 41% and current projections put the ratio at 37% for ’03.

Cotton Stocks/Use (World less China) vs "A" Index (1) – Adding the "A" Index to the right-hand axis, there’s been a discernible relationship between the two. As the stocks/use rose, prices fell. In ’02, the "A" recovered by 14 cents as stocks fell. Can we expect prices to move higher in ’03?

Cotton Stocks/Use (World less China) vs "A" Index (2) – Can any past years provide insight? Since 1991, there are 4 years with stocks/use ratios within 1% of the ’03 level. In 3 of the 4 years, the "A" has averaged somewhere close to 60 cents. In the other year, 1997, the "A" averaged 72 cents. Of course, there are many other factors that come into play beyond the one indicator shown here. Historically, China’s net trade position has a definite effect on world markets. General economic performance, competition from manmade fibers and prices of other commodities are just some of the other forces playing a role in cotton prices.

December Cotton Futures – Futures markets are showing similar pressures that we’ve seen in the spot market. December futures are now trading in the 56-57 cent range, falling from the low 60's in early July.

Cotton Farm Price vs. NY Futures – Looking at what this could imply for NASS’s farm price, the wedge between nearby futures and the farm price has averaged about 800 points. At current price levels, the normal gap would give a farm price below the loan rate, suggesting a maximum CCP. Obviously, the wedge fluctuates and futures price will move between now and expiration. If we add several cents futures between now and February, then we can talk about a substantially lower CCP.

Summary – In summary, we continue to look abroad to find a home for the majority of the US crop as domestic mill use remains under pressure. The balance sheet would suggest better prices, but we have to keep an eye on the underlying strength of demand and competition from manmade fibers.

On a final note, the CCC has announced it has transferred the sales of both its upland and ELS cotton inventories to The Seam. This will replace sales formerly handled on the Cotton Online Processing System (COPS). There have been some questions regarding potential impacts on prices. It’s our opinion that the sale of stocks on The Seam will have no different effect than what we’ve seen under previous COPS sales since USDA still controls the quantity and timing of sales. Also, if prices remain at current levels, it will not be a major issue since forfeitures should be relatively small for the ’02 and ’03 crops.