The Black Swan.
We talk from time to time of the market “backing and filling” as it follows a trend in search of a specific price point. The cotton market is in the “backing” phase of this cycle. An 86-88 cent market, basis December futures, has fallen to 81-82 cents. Certainly, a “backing” of this magnitude – six cents – begs the question, did we just absolutely miss the market?
True, we did not expect this slide, but we continue to feel comfortable with the price falling and still mainlining its uptrend. There is considerable confidence that the December contract will retrace the lost ground, and price “filling” will take the market back to the 87-88 cent level, possibly higher.
Cotton fundamentals are the same as last week, even last month, or even two months ago – with the exception that they are even more bullish. Significant adjustments have been made in supply, demand and carryover in the past few weeks.
USDA’s May supply demand report advanced the bulls argument. That is, demand was stronger than expected, the crop was lower than expected, and 2021 U.S. carryover dropped to a very bullish 3.3 million bales. Too, the outlook called for the 2022 carryover to be even smaller, currently projected at 3.1 million bales, but possibly as low as 2.3-2.8 million bales depending primarily on the U.S. crop in the Southwest, but also due to the loss of high yielding acreage in the Mid-South and Southeast.
In the face of the USDA bullish news, a Black Swan appeared. The market immediately suffered through two consecutive trading days of triple digit losses. The reason: the closure of one of the two major east/west U.S. interstate highway corridors crossing the Mississippi River, and the subsequent general closing of all barge traffic along the primary U.S. waterway.
The closure, at Memphis, left the commodity world with a very uncertain short run future. Futures markets offer a haven for price risk takers and price risk averters. A Black Swan event brings uncertainty to the market. It creates havoc and prevents the market from accomplishing its primary role of price determination or discovery of a fair price. It creates an unmeasurable risk with respect to price. Consequently, the natural and initial reaction for commodities is tumbling prices.
For example, the freedom related Tiananmen Square revolt in China in 1989 took commodity prices lower. A specific cotton example was the financial collapse of The Julien Company, a world cotton merchant. These two Black Swan events had immediate and short run direct detrimental impacts on cotton prices. In both cases, the market recouped the price losses and moved higher. The same should be expected for the current cotton market.
The release of the May world supply demand report validated the industry’s bullish price overtone in the market. The report pointed out the much tighter supply availability as the industry expected. It also pointed to a very strong and even improving demand situation for both U.S. and foreign cotton. Further, in its first comment surrounding the 2021-22 world cotton situation, USDA also noted a significant increase in demand during 2022 and a further decline in world cotton carryover. In fact, 2021-22 world carryover was forecast at 91 million bales – down 14 million bales below the estimate just nine months ago.
World consumption was estimated to be 5 million bales higher than at the same time a year ago, or about double the annual estimate of a 2% growth rate in cotton consumption.
Much of the Southwestern U.S. remains in extreme to excessive drought. The potential for even a marginally viable crop is reduced to almost nil without rain by June 1, just two weeks away. Even if the billion-dollar rain comes by then, the subsoil moisture level is so depleted that the area would have to receive beneficial moisture about every two weeks for the next three months – during the driest part of the season. Unfortunately, the forecast includes nothing more than a few isolated showers without any widespread moisture. To complicate the potential distress facing the Southwestern crop, the forecast calls for higher than normal temperatures.
The market will continue to look over its shoulder regarding the east/west transportation flow across the U.S. and the disruption to barge traffic on the Mississippi River. The latter potentially could be considerably more disruptive to the grain and oilseed markets than to cotton.
Expect cotton futures to do their “filling” and return to the high 80s and into the 90s.
Give a gift of cotton today.
