One of the forces driving world cotton demand has Peter Egli, director of Volcot America, Inc., leaning optimistic about prices next year. But he's a little worried about a potential slowdown in one economic sector.
Speaking at the Cotton Roundtable at the New York Board of Trade in New York City, July 8, Egli said global credit liquidity “has been providing consumers all over the globe with lots of spending power.
“This enormous money creation has its origin in the United States thanks to a very accommodating interest rate policy by the Fed. For several years now, we have had negative real interest rates. Banks, businesses and consumers can borrow money more cheaply.”
He noted that in 1980, the total U.S. credit market was 120 percent of the gross national product. In 2004, it's 305 percent of GNP. Last year alone, the total credit market has expanded by $2.7 trillion. We create $4 of new debt for every $1 increase in GNP. This credit creation is also occurring abroad, thanks to our escalating trade deficit.
“One problem we have is expanding our capacity to produce resources such as crude oil, industrial metals, etc. at the same pace as the money supply. What we have now is a lot of money chasing limited resources, which has led to a rapid price increase of these resources. This has given policy makers a false sense of security that inflation is under control.
“All the cheap products being produced in Asia are starting to add to the strength of these resources because the more of these cheap products we make, the more resources are being used up.
“I therefore believe that nominal prices of commodities will continue to move higher, possibly to levels no one would think possible. Just look at crude oil. Who would have thought that crude oil prices would move from $11 to $60 in just seven years. Copper has more than doubled in just a few years.
“You see this upper price pressure even in cotton. It's trading at 20 percent higher than last year despite the fact that we have one of our largest supplies ever for a single season. One could argue that the bearish supply-demand picture has been overwhelmed by this massive weight of liquidity.”
Another factor for strong demand is the growth of Asian economies. “A lot of people in the West still do not comprehend how big this new market in Asia really is. Japan emerged after World War II and had become the world's second largest economy by the 1980s. We're seeing a similar revolution in China and other Asian nations, except that we're dealing with 30 times as many people.
“There is no doubt in my mind that we will see continued growth in Asia's middle class. There are over three billion potential consumers that slowly but surely are getting the means to buy products that the rest of the world has been enjoying for decades.
“Over the next decade or two, we will see tremendous demand growth in Asia. In the United States, per capita consumption of cotton is six times as great as China and over seven times that of India. So there is a lot of room to grow for those countries. The demand growth will not happen in a linear fashion.”
Egli also noted that oil and energy prices will remain high “because the capacity to pump more oil on a daily basis is limited and consumption is growing rapidly in the Asian economies. This affects cotton prices in two ways. One is higher prices for man-made fibers. A rule of thumb is that for every dollar crude oil goes up, the price of polyester goes up by 1 cent per pound.”
On the downside, higher oil prices translate into higher input costs for cotton.
Egli says that U.S. cotton exports “will finish the season strong thanks to huge Step 2 payments. We expect that shipments will reach 13.5 million bales by the end of this month. This will put U.S. beginning stocks at around 7 million bales. A crop of 19.8 million bales in 2005 will create a total supply next year of 26.8 million bales.
“If we put domestic mill use at 6 million bales, then we have 20.8 million bales left to export. I believe we'll export 14.5 million bales.”
USDA currently has China importing 16 million bales, 8.5 million bales more than this season and as much as China has imported during the previous two seasons combined.
Egli, who just returned from a cotton conference in Shanghai, is a little less optimistic than USDA on Chinese imports.
“It was clear to me that nobody, neither the Chinese authority or the USDA, knew the exact supply and demand numbers for China. It's a huge guessing game. I believe that China will have higher ending stocks that what is currently estimated because China's crop is slightly bigger than reported, possibly by a million bales.
The timing of Chinese imports is very important, according to Egli. “While China will have to buy some additional quantities of cotton before harvest, possibly up to 2.5 million bales, sales will slow down considerably in the fourth quarter when China's own crop is coming on the market. The statistical shortfall will become most noticeable in the second and third quarters of next year.”
Egli noted that Turkey is expected buy 3.3 million bales in the world market, “but it starts with 1.8 million bales in stocks, which is half a million bales more than they had last year. This should hold them until their own crop arrives.”
Unless the production forecast changes drastically, Egli expects a buyers' market over the next six months, “which will put a cap on prices.”
He sees a short-term trading range for cotton of 50-60 cents. Longer-term, “I would not be surprised to see prices rise gradually to over 70 cents a year from now.”
“Please remember, I base my price forecast entirely on supply demand statistics. I believe the nominal price of just about anything tangible will see upward pressure.”
Dangers that lie ahead include the U.S. housing market. “If it falls out, it could lead to a contraction in consumer demand which could translate into reduced use of cotton all over the globe. Trade tensions could also escalate between the United States and China.”