Is there an explanation to this cotton market?

Prior to USDA’s Aug. 11 report, the 2006 U.S. cotton crop was estimated at 20.5 million bales and the world crop 115.6 million bales. Prior to the latest numbers, the U.S. crop estimate was based on historical average acreage abandonment and yield (16 percent when adjusted for the developing drought situation in Texas and a yield-per-acre-harvested of 770 pounds.

Early on (very early on, based on the March 31 USDA Planting Intentions report), believe it or not, there was actually discussion by analysts suggesting that the crop could be large because, after all, yields averaged 831 pounds in 2005 and a record 855 pounds in 2004 and we were coming off back-to-back

23-plus million bale crops with less acreage than expected for 2006. The market dropped about five cents during April and May.

Since the high in April and the low in May, the market has produced significant rallies twice — teased us with close to 59 cents in June only to lose about seven cents and then rally back to almost 58 cents a couple of weeks ago only to then drop three cents to where we now find ourselves.

For months, analysts (myself included) have dangled the 60-cent carrot out there — thinking that with the developing and worsening drought situation, that surely the 2006 crop will be less than last year and give reason to justify the higher prices we’ve all waited to see. Each time the market rallies, only to sputter out as we approach the magical 60-cent level.

In May, prior to the buildup of drought concerns, the crop was estimated at 20.7 million bales. And remember, this was considered possibly a low number.

While we all have been surprised and perplexed by the lack of market strength to date, the increase in the acreage estimate between March and June essentially added another one million bales to the U.S. crop.

It is hard to believe that 35 percent of the country’s cotton is in poor or very poor condition, yet the yield estimate is still this high. If the current yield estimate holds, perhaps it adds support to the notion that the higher yields we saw in 2004 and 2005 are a new “plateau”, i.e., from now on, perhaps even in poor years, we may do better than before.

But I think the verdict is still out — particularly for Georgia and Texas.

Another thing that has hurt the rally potential has been exports. While the 2006 crop will be down from last year, exports are projected to be down also — 1.35 million bales less.

In fact, total use (exports and domestic mill use) is expected to be down 1.8 million bales or about 8 percent. That’s fairly significant.

What we see happening is the market playing a game of give-and-take. Lower production, whether in the United States or worldwide, can lead to higher prices only if not offset by lower demand as a result of those same higher prices.

We also have to remember that the United States is in an export-driven market. Lower production in this country does not automatically lead to high prices (or at least sustained higher prices) if production in competing export countries is good and export supplies adequate.

Another piece of the puzzle is the loss of Step 2. In the absence of Step 2, U.S. cotton will have to be cheaper than before to remain as competitive in the export market.

December closed recently at 54.52 cents per pound. The 54-cent level should find support. A drop below 54 would be a bad sign.

On the upside, 57 to 58 cents is the barrier for now. If we are ever going to get to 60 cents, the market first must prove it can bust through 57 to 58. It has been tough so far.

If the crop is going to get smaller (less than 20 and closer to 19 million bales), then the September report must lead the way. I agree with the saying that “small crops get smaller” but eventually it must show itself.

If the crop is shorter than currently estimated (and quality may be in question too), then demand/merchant buying should lead the way to higher prices if the market (exports) can support it.

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