Thompson on Cotton: Demand Destruction Likely to Outweigh Production Shortfalls

    Cotton in bloom. ©Debra L Ferguson

    In their meeting last week, the Federal Reserve admitted being wrong in thinking inflation was simply transitory, a result of an economy rebounding from Covid. With consumer prices at a forty-year high and rising, they chose to slam on the brakes rather than tap them raising interest rates by seventy-five points.

    Such a zealous move heightened fears our economy is heading toward a deep recession. As a result, the Dow Jones, already in a death-defying freefall, fell another four percent on the week bringing its year-to-date losses to 18.3 percent. Similarly, the S & P 500 declined four percent and is down 23 percent since the first of the year, a bear market by definition.

    Up to now, to our good fortune, the cotton market has bucked the historical trend of moving in sync with the financials. For the past four weeks, new crop cotton prices have traded in a range between 1.30 and 1.15.

    It continues to trade sideways as it seeks to determine which will be shorter the supply of cotton or the demand for it. December futures closing the week at 118.29 for a loss of over four cents could be an early indication it is the latter as the once resilient consumer succumbs to these growing economic concerns.

    As for supply, the majority of the Cotton Belt is experiencing triple digit temperatures with this week’s forecast to be a repeat. In locations with ample soil moisture, this heat has cotton off to an excellent start. However, in the Southwest, where the bulk of the U.S. acreage lies, though planting is almost complete, the absence of rain will limit dry land production.

    Unfortunate as it may be, random May showers will keep initial abandonment from reaching the historic levels of 2011 even though it is expected to be well above average. We will have a better idea to the potential size of our domestic crop when the planted acres report is released on June 30. But you can bet the market is already trading a much shorter crop than the currently estimated 16.5 million bales.

    Export sales last week when combining all marketing years were a very respectable 408,000 bales. Somewhat concerning, China purchased 91 percent (371,000 bales). Such a large volume is indicative of buying for their reserves thus not true demand. Even so, currently there are 8.8 million bales of on call sales based Dec22 through July23. As we saw last year, this will provide some market support going forward.

    All this said, the ultimate fate of cotton prices lies in the hands of the consumer. It is becoming obvious their resiliency is waning in the face of escalating prices, higher interest rates, and declining asset values. The consumer sentiment index is at a current level of 50.2, down from 58.4 last month and down from 85.5 a year ago.

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    This likely led to retail spending falling 0.03 percent in May as compared to April where it was up 1.7 percent from the prior month. May was the first time in five months retail spending has declined. On an average, gas prices remain over five dollars a gallon. Every penny increase in the price of a gallon of gas is said to cost Americans four million dollars a day.

    The net worth of American households lost a half a trillion dollars in the first quarter of this year as both stocks and bonds declined in value. This negative wealth effect and the knowledge things are likely to worsen if a recession prevails is certain to weigh on the purchasing power of the consumer.

    Where to from here? Currently, world production is estimated to be 121.7 million bales while global mill use is projected to be 121.5 million bales. It is easy to surmise a significant decline in mill use is very probable given the ominous shadow world economies are casting around the globe. Thus, don’t expect cotton to trade sideways for very long.

    Managed funds are currently providing some support as seen by them increasing their net long position by 845 contracts last week to an equivalent of 6.3 million bales. Nevertheless, they are a fickle bunch and when its apparent demand destruction will outweigh production shortfalls, they will be taking money off the table.

    For those looking beyond this crop year, if we are correct in prices moving lower, its not a bad idea to book some 2023 crop. December 23 futures are now trading 93.14, a level higher than most started pricing this year’s crop. We, at Choice Cotton, would be glad to assist you in this.

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