The inversion of the cotton futures market in February could signal increased price volatility in the coming months, according to experts speaking at the Ag Market Network’s February teleconference.
Normally, deferred futures contracts are more expensive than nearby months because they have more carrying costs. An inversion is when nearby futures trade at a premium to deferred months.
In this case, stronger demand and projected smaller supplies in old crop cotton led to the inversion. On Feb. 10, July 2010 cotton futures closed for the day at 74.61 cents while December 2010 ended the day at 72.51.
“It’s going to be one remarkable year from a cotton marketing point of view,” said Cliff White, senior vice president of Olam/Queensland Cotton Group, Dallas, Texas, guest speaker at the teleconference.
“March cotton started off in the mid-70s, reached a low of 66.5 cents, and then we moved all the way back to 73.91 on Feb. 10. So we’ve seen a remarkable amount of volatility, and most of us expect this to continue over the coming weeks if not months.”
In February, USDA added a million bales to its forecast for 2009-10 cotton U.S. exports and dropped its estimate of U.S. ending stocks to 3.3 million bales. This created the lowest ending stocks-to-use ratio (21 percent) in six years. “Clearly the market has reacted to that,” White said.
But White did express some concern that USDA might have “jumped the gun a little bit on the export number. There’s no doubt that as we moved from the mid-70s into the 60s on March, U.S. cotton became the most competitive cotton in the world, and the last six weeks have seen a significant amount of export sales. But the biggest question now as we move back into the 70-cent range is whether those sales are going to continue. We’ve seen a significant slowdown in recent days in export interest.”
White says the market inversion “is very interesting. The supply/demand situation is tight, and it looks very bullish over the next six months. I believe the market stays in the 70-cent range, primarily due to a lack of coverage by mills.”
White says current cotton prices “are going to get stronger. New crop prices may very well get dragged up a little bit by what’s happening in the nearby months, but the big key is how many acres we get planted here, and how that crop starts off. If we start becoming confident that we’ll have a 15 million- to 16 million-bale crop, it will mean that the July-December inversion will likely be with us for quite some time.”
White says the biggest factor to watch for in new crop cotton is yield. “If we return to better yields across the country, production should be significantly higher than last year. It’s quite possible to see a U.S. crop in the 15.5 million- to 16-million bale range.”
Worldwide increases in 2010-2011production “could come from India,” says White, “but there is a big question mark on yield for them. We’ve seen the big explosion in Indian yields as they adopted Bt cotton. I think we’re starting to see that gain taper off. China’s production is anyone’s guess, but the information coming out suggests that cotton area will be slightly lower.”
Texas A&M professor emeritus Carl Anderson says a highly volatile market “is one that can make moves that we’re really not expecting. I would encourage all participants in the futures markets to be extremely careful in getting their risk exposure under control.
“When we get above 75 cents, you might do well to hedge some of the crop — like buying an out-of-the-money put option for some protection.
“Another thing that could create volatility in this market is the uncertainty of the new crop. Fundamentally, I find it interesting that we have an inverted market. If we pencil out numbers for new crop, we come out with a pretty tight situation.”
“I get a little excited about new crop and old crop,” said market analyst O.A. Cleveland. “Talking to merchants and co-ops, they have already begun to ration what they’re selling — specifically, they’re making sure that they hold back enough cotton to sell to their primary customers. To me, that’s a loud statement.”
Cleveland’s says his only marketing advice for growers this year is “Plant, plant, plant. Then when you get through, go out and plant some more.”
Mike Stevens with Swiss Financial Services advised producers to “take advantage of rallies, and replace any cash they have left with a call, or a call spread only. For new crop, if the prices are good enough for you to expand your plantings, make those prices good enough to get locked in.”
Stevens added that any kind of weather-related planting problem could cause the market to move up considerably.
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