Rose on Cotton: Cotton Merchant – Not a Grower’s Friend

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    Dec cotton futures on the ICE extended last week’s dramatic gains, picking up another 96 points this week and settling near the top of the week’s tight 133 point trading range. However, Dec tried numerous times this week, but failed, to break through resistance at 67.00. Open interest expanded in the Dec contact this week as the Dec – Mar spread remains inverted at 56. Cotton futures in China moved somewhat lower on the week while Indian futures moved higher.

    The market is now navigating the current of increasing certainty of shorter supply (at both the domestic and the aggregate world level) and growing certainty that world consumption will work southward from the USDA’s latest projection.

    For the remainder of the US production season, it basically boils down to the need for drier conditions (as bolls begin to open) across the mid-southern and southeastern states and increased rain over much of TX, OK and KS. AZ and CA will likely not be inundated with moisture as harvest season approaches, but the present El Nino is intensifying, which increases the likelihood for wet harvest conditions over many US cotton producing regions (but decreases the occurrence of tropical storm activity). The same El Nino is also causing hotter and drier conditions over India, the FSU and Southeast Asia at a time when moisture is needed. El Nino is likely not favorable for Australia’s yet to be sown new crop, either.

    While we are talking about supply, let’s revisit the shock and awe surrounding the USDA’s latest US production estimate. Most likely many have heard statements pertaining to such from our merchant friends. However, for the week prior to the USDA’s Aug WASDE report release, the aggregate commercial sector bought nearly 2M bales of US cotton from the board via a combination of short-covering and addition of new long positions.

    The aggregate merchant participants (and we are not singling any particular entity out) have the largest network of constant contact with the production sector and this allows them to frequently be forerunners of USDA WASDE production estimates. This, in turn, affords them considerable speculative profit potential (yes, merchants speculate in reference to their hedge position), and in such there is no wrong-doing. Indeed, per Commodity Futures Trading Commission data, they appear in reasonable agreement with the USDA’s production estimate – at least to the point of committing nearly $30M in margin requirements betting on the projection moving in the direction in which it did.

    From a strictly speculative perspective – and based on the average daily volume weighted average price for the periods Aug 5 – Aug 11 (entry) and Aug 12 – Aug 21 (exit or hold) – a conservative estimate of profit on such a 2M bale long position (or long/short net position adjustment) would be in excess of $30M.

    We concede that the merchant’s perspective is not quite so simple and that trading commissions and opportunity costs on capital were not accounted for. But, I think that it is quite clear that the merchant’s aggregate anticipatory pre-WASDE report market adjustments were quite profitable. Again, there is no wrong-doing in being profitable.

    Now, the merchant sector is necessary to our industry and we like them very much. And, although the previous fact-based statements may sound accusatory and just short of damning, I would not expect the merchants to share their proprietary information any more than I would do so myself. However, these entities are in the business of sourcing cotton as economically as possible from producers and selling it at the highest possible margin to mills. Hence, they absolutely should not serve as the producer’s primary counsel with respect to the marketing of crops. To be fair, as carriers of inventory, the cotton markets recent near flat to inverted structure has been a challenge to merchant’s profit margin.

    That being said, cotton merchants are no more a friend to the producer than is the official who would serve one with a summons to appear in court. That is, they are simply doing their job and fulfilling their industry space. However, if one were to receive a summons to appear in court, it is unlikely (and quite ill-advised) that one would do so without legal advice and counsel.

    The analogous counterpart in cotton marketing is the broker or agent – one whose business it is to look after the producer’s best interest. And both the producer and the broker/agent need analytical resources that are, above all else, comprehensive and objective. These resources and counsel should not be viewed as expenditures of convenience, but rather as sources of significantly increased revenue potential. Whether it comes from this column, the local broker, or some other independent source, information and perspective are some of the most valuable assets a producer can have. Bear in mind that, indeed, the merchant market sector agrees with US on this point.

    With respect to demand, weakness in emerging market economies and weakening currency values in many cotton hot spots (e.g. Turkey and the FSU) seem to be foreboding of consumption projections that are likely to come under pressure. On this matter we generally agree with most merchant sources that we have heard and read. We simply do not have the perfect ingredients of supply constraint amid strong demand pull to propel this market ever higher over the near-term. For such to occur, an unexpected bullish event will need to be made known to the market.

    For next week, the standard technical analysis is bullish; chart signals are also positive. Money flow into the Dec contract is improving, but the market has become overbought. Fundamentally, demand may be soft, but we expect next week’s export report to be stronger than this week’s was. A straightforward analysis says no, but some physical buyers may have realized that they waited too long before taking action ahead of the USDA WASDE report.

    Louis W Rose IV, PhD has worked with cotton as a producer, consultant, analyst and trader. Rose holds degrees in Education, Agriculture, Plant Science and Business (MBA) from AR St Univ, OK St Univ and the Univ of Memphis, respectively. He has held positions with Aon Reinsurance and Cargill Cotton. Rose currently provides analytic services for various clients and media outlets and is the co-founder of Risk Analytics, LLC, producers of The Rose Report, which he authors. For more info on The Rose Report or analytic services, please visit:

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