The China syndrome dictates U.S. cotton prices

Ed Jernigan, chairman and CEO of Globecot Inc., provider of in-depth information, analysis and consulting services for the fiber and textile industries, says U.S. cotton farmers, for good or ill, are living in the “Chinese Century” and their well-being dictated by how much, what kind and when China buys cotton.

China, Jernigan said at a recent Bayer Fibermax field day in Idalou, Texas, is in charge of the roller coaster that cotton farmers ride each year as they try to price their crops. He offers some “interesting points,” about China to make his case.

“First, China is the sixth largest economy in the world,” he said. “In 2004/2005 cotton use in China will reach 36 million bales, more than 35 percent of all cotton used worldwide. More than one out of every three cotton bales used in the world will be in China. “Approximately 50 percent of China’s cotton use goes into their domestic market and Chinese off-take of textiles and apparel, domestically, is growing by leaps and bounds.”

Jernigan said a little-discussed statistic about Chinese cotton is that production now follows price. “Growers determine what they will grow in the free market,” he said. “Even though there are grain subsidies, there are very little subsidies offered in cotton.”

Jernigan said China is the world’s largest textile and apparel exporter but also import a large amount of textiles and is now “a net importer of cotton yarn.” The Chinese imported 8.8 million bales of cotton in 2003/04, almost 26 percent of all world trade. China was also the biggest customer for U.S. cotton, 4.7 million bales, 36 percent of U.S. cotton exports.

And China’s current crop will not meet early expectations. A projected 31 million-bale crop has declined to 28 million. All that sounds like good news for U.S. cotton farmers, and in part it may be. But, China also is picky about the cotton it buys.

Jernigan says 70 percent of China’s cotton use is middling 1-3/32 inch or better quality. ‘In 2003/04 China imported very little 1-1/16 inch cotton,” Jernigan said. “Chinese ending stocks at the end of 2003/04 were mostly 1-1/16 inch cotton. And ending stocks were mostly low grade and selling at record discounts.”

Jernigan says China’s top grade is 129, comparable to U.S. good middling 1-1/8 inch. Price for that grade runs from $.77 to $.80 per pound at the mill. China’s lowest grade, type 527, corresponds to U.S. light middling 1-1/16 inch and trades from $.63 to $.64 per pound at the mill. “This is important for U.S. cotton growers because China is the worlds largest exporter of cotton, and will remain so,” Jernigan says. “The Chinese discount for light middling 1-1/16 inch is double that of the U.S. loan schedule.”

Jernigan insists that the U.S. loan schedule is “out of touch with export markets. The difference between a good middling 1-1/8 and light middling 1-1/16 inch, according to the loan schedule, is 7.15 cents per pound.”

The overall price of cotton would have to depreciate to make up for the difference. “That costs every grower money, not just growers producing low quality cotton,” he says. Jernigan says China will consume 36 million bales in 2004/05, which will keep China as the world’s largest consumer of cotton. “They cannot produce that volume.”

Jernigan says China has land use issues. “They had a trade deficit in agricultural food products in the first six months of 2004, so the government now has a strong interest in promoting grain production.”

Shifted emphasis to grain will mean China remains a net cotton importer for the immediate future, at least, Jernigan says. “And imports will be focused on middling 1-3/32 inch and higher grades during any type of crop problem.” Quality, Jernigan says, remains the key to U.S. export success. He says a bull market prediction late last summer did materialize when China got into the market and says that rise was fortunate. “It did not last as long as we expected, but one interesting thing did happen after the futures market began to decline. The bull market we expected to see in outright prices began to occur in the basis.”

He says the price of Australian cotton, strict middling 1-1/8 inch, did not fall by the same amount, 11 to 12 cents compared to 27 cents per pound. “We had a record basis. The Australian cotton, which is sold on the futures price, traded as high as 2000 points on the futures.”

Jernigan says Australian cotton is similar to Fibermax cotton grown in the United States and he encourages growers who produce Fibermax to consider the Certified Fibermax program to garner available premiums. Jernigan says too many U.S. growers continue to produce “discount priced cotton because of the U.S. base grade. Strict low middling 1-1/16 inch cotton is not the world standard for quality cotton.”

He says the U.S. premium discount schedule is “out of touch with world markets. There is not enough premium in the schedule for staple length and fiber strength. (There) is too small a discount in the schedule for short staple, micronaire, and for lack of uniformity.”

He also says the U.S. Memphis/Eastern MOT is a generic description that has no differentiation for product and selling without a specialized higher grade cotton is costing the U.S. growers a lot of money.” Jernigan says Georgia’s problems with quality — short fiber, lack of uniformity and bark — show what producing for yield instead of quality can do to a cotton market. “In 2004/05 mills representing more than 75 percent of the U.S. domestic consumption have announced they will not buy Georgia cotton, or if they do will only buy with specific quality parameters.”

Jernigan says the U.S. farm program will change to meet a new marketing objective. “The U.S. farm program was designed for a different time, a time when the United States consumed the largest portion of its cotton and exported surplus. Surplus was sold on price.”

He says the farm program will be redesigned, “most likely penalizing growers producing commodity type cotton. Producers centered on producing commodity cotton will not survive,” he said. Jernigan said services such as the Certified Fibermax Program allows growers to take advantage of the demand for higher quality cotton.

Jernigan says current U.S. and world production and usage levels dictate that U.S. stocks are not likely to get tight. “If production drops from 21 million bales down to 17 million and consumption is at 6 million, growers still have to export 11 million, not a record but a large volume of cotton.”

He says that scenario puts pressure on cotton prices every year. The current base grade for cotton only adds to the problem, he says. Jernigan says China also will affect market price this year by timing. “They will buy more cotton than they did last year but the question is when will they buy,” he says. “China will focus on importing middling 1-1/8 inch. They will buy some short staple but only on price. When China is in the market, they will not buy in panic as they did last year. There will be more hand-to-mouth buying, so their timing will play a crucial role (in price movements).”

Jernigan said other competitors also will play a role in filling world demand. “I think extreme volatility will continue. The market will rally when the focus is on China but will plunge when the focus is on the United States.” He says the United States faces a major hurdle to export a record volume of cotton this year.

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