By Andrew Woods | Source: ABARES, ICAC, Cotton Inc, CRB, Cotlook
Raw cotton stocks are expected to be around 85% of annual consumption by the end of 2013-2014 with about two thirds of these stocks held by the Chinese government. High cotton stocks pose a threat to future cotton prices and in doing so pose some threat to wool prices.
This is the third time during the past thirty years that the Chinese government has built a large stockpile of cotton. The build-up is un-sustainable, and the Chinese government is reported to have flagged changes to the stockpile policy for the 2014-2015 season.
In Figure 1 the opening stocks to use ratio is given for the cotton market from 1980-81 onwards. The Chinese part of the stocks to use ratio is highlighted. Chinese stock levels peaked in the mid-1980s, late 1990s and have risen sharply again since 2010-11. A cotton prices series (the Cotlook A index in US cents per pound) is shown for the same period.
Cotton values have a high, positive correlation with wool prices. Any grave threat to cotton prices poses some threat also to wool prices. The median stocks to use ratio for cotton for the past twenty years has been 49%, so the expected ratio of 85% at the end of this season is well above the norm. Excluding China, the stocks to use ratio is expected to be 48% at the end of this season, which is about the norm.
At some stage the Chinese stocks will have to be reduced, implying cotton prices will come under downward pressure. Changes to the Chinese policy regards stock purchases have been flagged for next season (2014-2015). In the late 1990s, stocks built to 58% of consumption with China holding half of the world stocks. In 1999, a new policy to reduce these stocks over a four year period was introduced. Sales were made, equivalent to 7% of consumption per year (in 2000/2001).
During the past decade the Chinese government has been comfortable in carrying around 4 m kg of cotton stocks. To reduce cotton stocks down to this level it will require sales of some 7 m kg. Assuming a period of 4 years is chosen for this to occur, it would once again amount to around 7% of consumption per year in added supply. This will put some downward pressure on cotton prices.
On a positive note, the Chinese government is well funded and will not want to cause undue disruption to the cotton market, thereby hurting the domestic Chinese cotton growing and processing sectors.
Wool and cotton prices tend to follow similar cycles and trends (as does polyester staple prices). With cotton stocks at high levels it appears likely that cotton prices will be under some downward pressure while stocks are reduced.
The last time China reduced stocks in 1999-2002, it took four years. It’s important to keep in mind that, during that time, fine wool prices had a huge boom (1999-2001) and the overall wool market had an end of stockpile boom in 2002.
Wool and cotton prices are linked but they do not always follow the same path.
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