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Bizarre & enigmatic cotton situation confronts 2013
Jan '13
As we enter a new year, we are confronted with one of the more bizarre and enigmatic cotton situations in recent memory. What makes price analysis currently so difficult is that we are essentially dealing with two entirely different markets - China versus the rest of the world. These two markets operate under markedly different price structures, with Chinese cotton and yarn imports creating an important link between the two systems.    

The pace at which the Chinese Reserve has been procuring domestic cotton via its auction mechanism this season is simply mind boggling. As of this week the Reserve has already absorbed close to 5.2 million tons (23.5 million statistical bales) into its stockpile, which equates to around 75 percent of the Chinese crop. Total Reserve stocks are now estimated at close to 10 million tons!

With local cotton being prohibitively expensive as well as in short supply, Chinese mills have continued to focus on imports of raw cotton and yarn, thereby siphoning off cheaper supplies from the rest of the world.

In the first four months of the current marketing year (August to November), raw cotton imports have already amounted to 5.3 million statistical bales, implying an annualized rate of nearly 16 million bales. Although that’s not quite as much as last season’s 24.5 million bales in imports, it would still be more than enough to neutralize the seasonal production surplus in the rest of the world, which according to USDA figures amounts to 14.4 million bales in 2012/13.

In addition to imports of raw cotton, China continues to be a keen buyer of foreign yarn, nearly doubling the pace of imports from the previous season to an annualized rate of around 6.5-7.0 million bale equivalents.

This in turn is boosting mill demand in places like Pakistan, India and Vietnam, who are the main suppliers of this yarn. Given the rather dramatic shift in mill consumption from China to other markets over the last three seasons, it is quite possible that mill use outside China is being underestimated, with recent anecdotal evidence pointing in that direction.

There have been rumors over the past couple of weeks that the Chinese government may start to release some of its stocks by forcing mills to take three bales of Reserve cotton at a price of 19,000 Yuan/ton (= 138 cents/lb) for every bale that they are allowed to import under a sliding scale duty. Although this price would be cheaper than the 20,400 Yuan/ton the Reserve has been paying to farmers, it is still very expensive when compared to international values.

Some traders fear that such a 3:1 ratio scheme may have a negative market impact, but we don’t believe that to be the case. There may be an initial knee jerk reaction when the new policy is announced, but what matters in the long run is that imports are likely to continue, albeit at a reduced rate.

This is important in regards to international cotton prices, because if plantings in the rest of the world were to drop by 15 percent next season and demand increased by a modest 2 percent, then production and mill use would be at about the same level outside China.

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