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2014: Outlook on Cotton and Pricing

It may be early yet to set estimates for cotton pricing in the 2014/15 crop year, but when it comes down to it, whatever next moves China makes will have a heavy influence on the market.

In an interview with Sourcing Journal, Jon Devine, Cotton Incorporated’s senior economist, said, “Where the prices are going to go is going to be determined by how much cotton China is going to import.” He added, “China is driving nearly everything in terms of price direction right now.”

Under China’s current reserve program, the country is sitting on hoards of cotton. The U.S. Department of Agriculture (USDA) has forecast that China will be holding about 60 percent of all the cotton stored in bales, or warehoused cotton, at the end of this crop year, Devine said.

“China’s cotton reserve is the mechanism that enforces the guaranteed price,” Devine said. “The government buys this cotton at a high guaranteed price and then withholds it from the market. This gives them a way to control supply and therefore to control prices domestically.”

Coupled with that, the country’s import quota restricts the amount of cotton that can come in from the world market. China’s membership in the World Trade Organization (WTO), however, requires them to let a certain quantity of cotton in each year (894,000 tons, or about 4.1 million bales), but anything allowed in beyond that level is essentially at the government’s discretion.

“The Chinese government decides how much will be allowed into the country or not and, of course, whatever they allow is going to be imported because it’s much cheaper than domestically available cotton,” Devine said.

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Imports at the yarn stage of manufacturing don’t have the same tough restrictions as for cotton fiber, so fabric manufacturers in China can import yarns from countries with cheaper fiber prices to help mitigate the issue of expensive domestic cotton.  Yarn imports are not subject to the same complicated set of tariffs that exist for cotton fiber imports and there are no quantitative limits on the volume of yarn that can be brought into the country.

“What China’s mills have been doing over the past couple years is they’ve been importing record volumes of cotton yarns from abroad,” Devine said. In 2013, Pakistan, India and Vietnam were the largest exporters of yarn to China. “A lot of the yarns that they’re importing are lower count cotton yarns, those type of yarns are especially difficult for Chinese spinning mills to produce at competitive prices given high Chinese fiber prices.”

As a result, Chinese spinning mills have shifted their operations toward finer count yarns such as those used in high quality dress shirts and these higher count yarns call for higher grades of cotton. In turn, there has been some increase in demand for higher grade cotton for export into China, Devine said.

None of what takes place in China’s cotton market happens in a vacuum, Devine said. “China is the world’s biggest consumer of cotton and they’re also the biggest importer of cotton,” he said. “So, as you’d expect, if China changes anything relative to their import demand, that’s going to have an impact on cotton prices around the world.”

According to Cotton Inc.’s January “Cotton Market Fundamentals & Price Outlook,”  given China’s huge reserves, the USDA forecasts that China will import 46 percent less cotton than the last crop year (20.3 million bales in 2012/13, 11 million in 2013/14). The report noted that so far into 2013/14, Chinese import data show that cotton imports are 16 percent lower than during the 2012/13 crop year based on data available from August through December.

“What we’ve seen over the past couple years is that China has been importing a lot of cotton; they imported more than 20 million bales in the 2011/2012 crop year and also the 2012/2013 crop year,” Devine said. “Their historic average is about 11 million bales, so for the last two years they have been importing at levels nearly twice their historic average. With lower Chinese mill-use,  a situation has developed where  China is sitting on so much cotton that at some point they’re likely to slow imports.”

And when China imports less cotton, supplies should start to accumulate outside of China. This is relevant for global cotton prices because it should imply downward pressure on prices outside of China.

Cotton Inc. is not worried about the rising demand for synthetic fibers effecting the demand for cotton. The decrease in cotton prices could be expected to help cotton recover market share lost in the wake of the price spike during the 2010/2011 crop year. Devine said,  “Despite some of the challenges cotton faced in recent years, cotton was able to hold onto its majority share and I think the repeated consumer research finding which tells us that consumers prefer cotton in the clothes that they buy is a major reason cotton was able to hold even with unprecedented price pressures.”

Devine said cotton’s loss of market share was an illustration of the concept of inferior goods from economics.  In economics textbooks, this concept is commonly described in terms of beef and chicken, with the assumption that most consumers prefer steak.  However, when beef prices increase, consumers may choose to purchase more chicken due to cost pressures.  “Switching in fiber market was analogous.  With lower cotton prices and consumers’ consistent preference for cotton-rich apparel and home textiles, it could be expected that cotton’s share will rebound in coming years.”

Through its new “Customer Comments Project,” Cotton Inc. is tracking consumer sentiment with regard to apparel by scouring brand and retail websites and sifting through customers’ product reviews. The findings, according to Devine, have shown an uptick in customer complaints about pilling, odor retention and general decreases in quality.

“I think some of that probably could be attributed to the fact that we’ve seen substitution from cotton to some of those substitute fibers,” Devine said.

In terms of acreage, it is still early to discuss what will happen in the coming crop year as planting for 2014/15 hasn’t yet begun, but Devine said there are some expectations he feels will hold.

“Globally, I think we can probably say acreage will be flat to slightly down,” he said. “The country where people are expecting the biggest decrease in acreage this crop year is China and that’s likely going to be due to some of the changes that are expected in China’s cotton policy. So, everything always goes back to China.”

China’s government announced last month its plans to potentially replace the country’s cotton reserve program with government subsidies.

While they haven’t yet released full details, Devine said it looks like China will be trying to get away from the system based on high guaranteed prices and moving toward a system of direct payments which would reduce price pressures spinning mills face but still continue to support cotton growers.

As far as the rest of the world market, Devine said, “When you take a look cotton production in other countries, we’re not expecting any major changes”

The biggest factor the U.S. planting season could be the market’s decrease in corn prices.

“Corn prices have come down about 50 percent over the past year. With cotton prices generally stable over the same time period, that’s made corn a less attractive option for growers,” Devine said. “As a result, cotton could pick up some acres from corn and potentially some other grains.”