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Cotton Inc.’s Jon Devine Digs Deep Into What’s Behind Raw Material Price Spikes

Jon Devine, senior economist at Cotton Incorporated, said cotton prices‘ climb to $1.05 per pound began with the Phase One trade deal between the U.S. and China in 2020.

“That was a significant factor in the cotton market,” Devine said Tuesday at the Sourcing Journal Summit. “But then, along came Covid and the market dropped. The cotton market bottomed out at levels [of] just 50 cents per pound in late March, early April of 2020. Since then, cotton prices have been part of the everything rally that has been taking place for the past year and a half.”

Charting price spikes, such as those for cotton, can define a rising trajectory “by a series of higher lows,” and when you take a look at what’s happened since the spring of 2020, “we can definitely define an upward trend,” he said.

“The latest challenge to that trend occurred just a few weeks ago when we started to have some macroeconomic concerns surface from China,” Devine said. “That pulled cotton prices all the way down to their trend line. But what you’ll notice is that prices did not break through that downward trend, instead they rebounded.”

That can be a signal that can attract investment into the market. Looking at the volatility that has hurt the cotton market in recent weeks, there has been a surge in speculative investment, he noted. He cited Commodity Futures Trading Commission data that showed a 50 percent increase in speculator net long positions in cotton futures.

“So, the strength of the upward trend that we’ve seen in recent weeks has been driven in large part by speculators,” Devine said. “But before he wanted to go around and blame them for all of your lows, which you should remember is that speculators are people and they’re placing their bets according to the information that they have.”

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He said pointed out the fundamental reasons that are likely contributing to the increase in cotton prices. One of those is strong downstream demand, particularly the U.S., with consumers showing a strong appetite for clothing and spending more than anticipated in the absence of Covid and the stimulus that followed.

“In addition, we have seen some strong demand from China,” Devine said. “In the four to five weeks in September, we saw the U.S. sold over 1 million bales…The last crop year, which is the year ending in July, we saw the U.S. ship a total of about 5 million bales to China. So, we saw essentially 20 percent of our annual export demand being sold to China in a span of only one month, and that coincided with some of the strength that we’ve seen in cotton prices.”

Devine took note of the price spike that occurred in 2010-2011, when cotton prices surged from 80 cents per pound to over $2 per pound, so “thoughts of potential gains like that again may be pulling speculators back into cotton.

“But…we’re not facing the same supply-demand situation that we had in 2010-2011,” he said, using a chart to show the peaks and valleys of cotton prices. “If you took a look at the supply demand situation back then in terms of global production or global cotton harvest and global mill use, you can see that leading up to the 2010-2011 crop year…we had four consecutive years of production deficits…Things really came to a head in 2009-2010, when we had a significant shortfall. Cotton prices coming out of that were not attracting growers, and along with weather issues, resulted in this big deficit.”

Moving back to the current price crisis, Devine noted that when a new crop year begins in July, the industry is completely dependent on the amount of cotton stored in warehouses.

“When you do see warehouse supply get tight, that can cause some concern in the market,” he said. “Something that’s very important to consider is the big hangover in production that occurred in 2019-2020. Before Covid hit, we were expecting that crop year to have production consumption relatively equal, but when Covid shuttered a lot of the world’s spinning mills, we saw a very large $20 million bale surplus merge. This is the second largest surplus we have a record, only behind the surplus that emerged after the price spike in 2011-2012.”

The crop year that ended in July 2021 yielded a production deficit globally of about 7 million bales, while the current crop year forecast expects about five million bales. This is still a net positive level compared to 2019, he noted.

“So, the market is not facing a supply scarcity situation,” he said. “Projections for the end of the current crop year, which will end in July of 2022 are that global warehouse supplies will rank in the top seven all time. That’s only behind the volumes we had [in] the COVID-affected years the past two crop years, and only behind the big surge in production and stocks following the price spike that occurred in 2010-2011.”

The bottom line, Devine said, is there’s little evidence of extreme scarcity in the market right now, “which makes this runup on cotton prices, all the more remarkable.”

If there is emergent scarcity, it’s happening in America, he pointed out. The U.S. did have an increase in its stock-to-use ratio with the onset of Covid, but last crop conditions were much tighter, which had a lot to do with some of the bad weather last year and also a very strong demand from China for exports.

“In the current crop year, we do expect to see U.S. stocks-to-use ratio climb a little bit,” he said. “One reason for that is that we are expected to have a bigger crop. The current USDA forecast is that we expect the U.S. cotton harvest will be 25 to 30 percent larger than it was last year. A lot of that has to do with beneficial weather, particularly out in West Texas, which is a very important region for our crop. The global economy has been doing pretty well. We may see the U.S. expand sales beyond China, but there are some questions. Covid’s out there, there are some questions about the trajectory for economic growth. So, there is some uncertainty, particularly from the demand side of the U.S. balance sheet, but overall, the crop looks bigger.”

Devine said there’s clearly high demand in the pipeline, from consumers and retailers to manufacturers and fiber firms, which is causing price increases across the board.

“Something important to keep in mind is that our cotton growers are paying attention to these prices,” he said. “Dollar cotton will buy more acreage…We’re pretty much in step with corn and soybeans, but this latest charge brings cotton fare and above those other crop prices, and that should bring a supply response into the market as we get into planting on next spring. Eventually the cotton market may start to pay attention to the supply side. We’ve got cotton stocks out there and we’ll have more cotton production coming down the pipe, given these very high cotton prices.”

The U.S. is the world’s largest supplier of extra-long staple pima cotton, with about 90 percent of that cotton produced in California, which has been very dry. The lack of water means producers haven’t been able to grow as much as they would like. Whether or not that drought resolves itself will depend on when it may get a supply response.

Touching on the synthetic fiber market, chemical production China has slowed due to the power outages that are occurring and their energy prices are expected to increase for the short term. That includes oil, which is an input into polyester production and other synthetics.

“It looks like we’ll have some raw material inflation across the board,” Devine added. “It has been occurring in cotton and at some point, we should see a supply response to help alleviate the situation. Of course, the question is when is the cotton market going to start paying more attention to what may be existing in the market in terms of supply and what may be available in the coming crop year.”