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It Was the Best of Times, It Was the Worst of Times: Cotton’s Struggle for Predictability

Over the past several months, there has been a great deal of contradictory reporting on fluctuations in the price of global cotton. Some media outlets predict that the global crop will be smaller this year, and low prices carried over from last year have encouraged farmers to plant crops other than cotton. By restricting supply, these observers fear that lower supplies of cotton will eventually translate into higher prices — mill demand will eventually increase beyond current levels. On the other hand, some media pundits suggest that low prices will continue to be the norm for the foreseeable future. A better crop in Texas will add to growing global stocks — contribute to unsold cotton globally — and will keep supply much higher than demand from textile mills, something many pundits fear will remain anemic.

Frankly, when the news media issues conflicting reports, there is reason to be concerned. It suggests no one really knows what is going on. To be sure, mill buyers of cotton are fretting over a seemingly unstable global market for cotton. What is a buyer of cotton supposed to do?

To review recent history: cotton futures prices topped $2.00 per pound in 2011. A year or so before that, the big debate in the cotton world was whether cotton could reach the history-setting level of a $1.00 per pound. How things changed! There are a number of reasons for the surge in cotton prices in 2010/11. Simply stated, there was a shortage of the stuff. A number of factors came together to create a supply imbalance not seen in cotton since before World War I.

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First, global stocks of cotton were drawn down sharply as less cotton was grown and shipped through the global supply chain due to competition from other crops. Many farmers switched to different crops when cotton was below 80 cents per pound. In particular, the ethanol boom of a few years ago convinced many farmers it was time to switch into corn production as corn paid better than cotton. Previously, cotton had been stuck in an anemic price range of about 40 cents to 70 cents per pound. Corn, on the other hand, soared when government support of ethanol production pushed that commodity up to unheard of price levels with corn now worth more as a fuel additive for our cars than as fuel for our stomachs!

Next, there was bad weather. Flooding in Pakistan, a poor crop in China and a bad Monsoon in India combined to seriously undermine global cotton production in 2010/11. As much as one quarter of the global cotton crop was somehow affected by this bad weather and at a time when there was less cotton grown because it was more profitable for farmers to grow other crops.

Finally, government actions further aggravated the situation. In 2010, India, one of the world’s largest cotton producers, slapped export quotas on raw cotton and yarn in an attempt to maintain a good supply of moderately priced cotton for its textile industry. But cotton prices in India did not moderate, and all this policy did was to cause an acute shortage of cotton and yarn in China, the major export market for these products. As a result, stocks of cotton in Chinese government warehouses began to run low (which is certainly not the case today). Moreover, without the ability to import freely cotton and yarn from India, and faced with a poor domestic crop and low country-wide inventories Chinese mills had little choice but to enter the world markets and buy everything in sight. This buying has continued until just recently.

And there is more. When the grip of the global recession began to ease on economies everywhere, demand for textiles and apparel rose. Over the past 50 years or so, the U.S. and Europe often led global recoveries, but in 2010, China played a major role as an end consumer of products. The Chinese government pumped huge amounts of money into their economy in an effort to ward off recession. It largely succeeded. Domestic demand soared as a recession was avoided in China, but demand for cotton jumped to levels not seen in years as local mills struggled to produce enough product not only to meet restored demand in the U.S. and Europe — but the demand of local consumers, as well. Chinese textile producers are no longer solely reliant upon the global markets for their livelihood. Domestic sales have now become a new standard for the world’s largest textile industry and have even placed further demands on the cotton supply chain.

There are also other factors that have contributed to the run up in cotton prices, some more obvious than others. Higher energy costs have played a role not only terms of shipping cotton but also physically to grow the crop. There’s another factor too — speculators in the cotton market. A weak U.S. dollar helped to inflate commodity prices, although more recently this trend has moderated. It is often said that the wherever gold goes so does cotton. During the price run up of 2010/11, a haven for investors was gold and other commodities. When the stock markets were shaky during the recession, there was a lot of money to be made betting on higher commodity prices. In terms of cotton, sensing a quick buck, hedge funds swooped into the market just as the run up in prices began and the sheer size of their positions elevated prices well beyond what has normally been the case in the cotton markets. The cotton market has not been the same since.

And, yes, there is one other factor: psychology. Panic was driving the market. Fear of not being able to secure a supply of cotton left many clothing companies scrambling and even more mills wondering if they could stay in business as the price continued to rise and if there was a consistent supply of cotton to be had at any price. It was this panic in the marketplace that helped to elevate cotton prices even more. For many years, the retail and apparel side of the textile supply chain set the rules for what it was willing to pay for its raw materials be it fabrics or raw cotton. But the panic in the market of 2010/11 weakened the grip of these companies. Raw material suppliers were able to gain some ability to push higher costs on their customers and, indirectly at least, to the customers of those customers.

Why all the history? Simply put, all of these factors put the cotton industry in the precarious position of meeting soaring demand from a reduced production base. Although the market is somewhat calmer today, this is a scenario that could repeat itself. Needless to say, today’s cotton market is far from certain. However, predicting where the market will go is more difficult than ever.

To borrow from the British author Charles Dickens: It was the best of times, it was the worst of times. It was the age of wisdom, but it was also the age of foolishness. This really sums up the cotton and textile business over the past few years. The economic crash of 2008, which was preceded by the boom years of 2005-2007, not only rattled the confidence of many, but also laid bare for all to see that the previous boom was really more of a bust in disguise. The global financial system proved to be a house of cards, built with a shaky foundation and even shakier rafters. For cotton and textiles, as that house collapsed some were hit by the falling debris; many of the world’s best known cotton merchants and textile mills are no longer in business today, casualties of the times, for certain.

Nevertheless, the past several years have challenged the global fiber markets like never before. Until this point, world fiber demand expanded every year over the last two decades, climbing to a record high by 2007. But as aggregate demand plunged for virtually all fibers in 2008, demand for the two most-widely used fibers in textiles and apparel–cotton and polyester–accounted for the bulk of the loss in total fiber demand.

The timing and confluence of several disastrous economic undercurrents came to a crescendo just a few years ago, resulting in an enormous collapse in aggregate demand for the world economy on record. For the first time since the Great Depression, global economic output shrank in 2008, with wide-ranging repercussions across geographies and industries. As the world economy contracted, per capita incomes in many markets fell, standards of living declined, and purchasing patterns shifted away from luxury and discretionary items to more purchases of core staple items.

On the supply side, lukewarm credit markets and swings in foreign exchange rates limited manufacturers’ ability effectively to manage financing, production, and inventory costs, resulting in an unprecedented retrenchment in output across the supply chain. This receding economic tide lowered virtually all ships, including global demand for textiles and apparel, resulting in an unprecedented contraction in global fiber demand.

Over the decades, global mill demand for cotton grew in response to higher standards of living around the world, expanding disposable incomes and burgeoning consumer preference for cotton in many key markets. Driven by aggressive promotional efforts in certain markets, global end-user demand for cotton climbed to unprecedented heights in 2007, only to plunge at a record rate in 2008 from the fallout the global economic crisis. Cotton demand by the world’s textile mills fell sharply from the year before, tripling the second-biggest fall on record set in the wake of the global economic slowdown in the 1970s. This drove mill usage of cotton down to a level that erased gains recorded over the previous half decade.

Cotton mill activity posted a modest rebound in 2011/12, drive primarily by renewed activity in China, India and Pakistan, and mills used more cotton in the 2012/13 marketing year — a level comparable to the average annual increase over the decade leading to the 2008/09 crash. Even so, mill demand for cotton is still below the 2006/07 record and stands as the third lowest in the last five years.

Contributing to this slow recovery, mill demand will likely see only a modest improvement in the new marketing year as growth in retail end-demand for cotton textiles and apparel is expected to remain uneven, if not lackluster. Forecasts from the IMF suggest that a rebound in the global economy will continue to be sluggish, weighed down by advanced economies as a group and skittish growth in China, India and other developing countries. With the bulk of global cotton textile and apparel end-demand happening in the U.S., EU and Japan, this dims prospects for a rapid rebound in the sector, imperiling the near-term outlook for cotton mill demand. Looking further ahead, global aggregate output will re-accelerate in the next five years closer to trend, helping to buoy resurgent mill demand for cotton.

However, one wildcard continues to plague the market: China’s enormous stocks of cotton. What will the Chinese government do with all the cotton stored in its warehouses? Much of the global consumption in cotton since the crash was actually the result of the China Nation Cotton Reserve replenishing its stores. When cotton soared to $2.00 per pound, China suffered from diminished inventories. It appears the government does not want to repeat that mistake. Yet, it may have take matters to an extreme, as more than half the global inventory of cotton remains in Chinese warehouses. What will China do with all that cotton? Dump it on the open market? Use the inventory to help mitigate price fluctuations? Does domestic politics play a role? The answers to these questions will tell the story of the global cotton market over the next five years, if not beyond.

As has been the trend over recent years, China is expected to realize the lion’s share of the rebound in global mill demand for cotton over this five-year horizon. Just a decade ago, Chinese mill demand accounted hardly one-fifth of global cotton usage. Now, over two in five bales around the world are used in Chinese textile mills. Along with the rest of the world, Chinese mill usage of cotton plunged in 2008 in response to a dearth of downstream demand. Assuming Chinese cotton demand only rebounds in coming years to its 11.2 million-ton record set in 2007/08, this would account for half the increase in anticipated global cotton demand.

Considering recent evidence showing cumulative fixed asset investment in China’s textile industry expanding (although modestly) again in 2013, mill demand should respond in turn in 2014, if not by stellar increases. Most importantly, on the short term, this implies Chinese mills will at least maintain market share opposite other cotton-consuming nations around the world, maintaining their presence on the global stage, despite challenges from smaller suppliers such as Vietnam and Bangladesh.

Longer term, worldwide cotton demand will likely continue its path of expansion each year, but growth may decelerate over the next ten years, owing to creeping market share from synthetics, increasing saturation of cotton end use in non-traditional markets, and prospects for longer-term slowing of the world economy. For China, however, long-term prospects are not particularly bright, as Chinese producers will increasingly lose market share to small low cost suppliers in Bangladesh, Vietnam, Cambodia and elsewhere in South Asia. A continuing drag on cotton prices will be growing global stocks in China and elsewhere. Lower prices, in turn, may translate into even lower production levels of cotton as farmers could switch acreage to higher value crops.

Moreover, an issue likely to continue to constrain prospects for rapid growth in global cotton demand in the long term is synthetic fibers’ increasing share of total fiber demand. Cotton was the dominant fiber used globally in textile and apparel applications for nearly four decades. But with each passing year, cotton continued to lose share to synthetics–particularly polyester–as demand for synthetics grew faster. By 1993, cotton had relinquished its dominant position to synthetics, never to regain it again. This trend to will likely continue over the next ten years, limiting the potential growth rate in cotton demand. Further, the volatility in cotton prices witnessed in 2010/11 only hastened a movement by mills to more cost-effective synthetic fibers — exacerbating an already deteriorating market share situation for cotton globally.

To sum up: 2014 promises to see a modest rebound in global textile demand in contrast to the record contraction witnessed in 2008. While some markets–particularly across Europe and South America–will be slower to respond to improved downstream demand signals, other markets–particularly in China–are already enjoying somewhat improved growth in textile output. Longer term, global cotton mill demand to continue to expand as a result — albeit at a slower rate than witnessed in the recent past — but will continue to lose market share to synthetic fibers.

By Robert P. Antoshak

Managing Director

Olah, Inc.