Okay, fellas. This is the rally we've been anticipating and hoping for. Now it's time to get serious-- to evaluate your position, consider alternatives, and make a decision. It's not an easy decision but nevertheless one that has to be made.
 

December cotton futures prices now stand at close to 64 cents per pound- the highest level since March. Prices have gained roughly 5 cents per pound since May 4th.     Prices have been sparked by mounting weather concerns, particularly in the Southeast and west Texas. Prices have also responded to continued improvement in use of cotton by foreign mills. Analysts report that China may be in the market to import cotton.     USDA's May supply/demand report showed that 1999/2000 world mill use of cotton is now forecast at 90.53 million bales- up 320,000 bales from last months estimate and 4 million bales above this same time last year! The interesting thing to note is that all this growth in mill use of cotton is coming from outside the US. This is an important key to the 2000 crop price outlook.

   USDA's May report shows that US exports of the '99 crop are now expected to reach 6.6 million bales. Since Step 2 funding was restored this past fall, US export potential (USDA's monthly forecast) has increased by roughly 1 million bales.

   Further fueling the present price rally, May's report was the first USDA estimates of US and world supply and demand for the 2000 crop. Compared to the '99 crop, world production is forecast to decline 1.28 million bales, consumption increase 1.47 million bales, and ending stocks fall 6 million bales. US production was pegged at 19 million bales, exports at 8 million bales, and ending stocks at 5.1 million bales.

   Turning our attention back to the US weather, dry conditions are worsening. Interestingly, however, planting appears to be ahead of last year and ahead of the 5-year average in most states. This could mean that more of the crop is subject to early season weather concerns such as we are experiencing now but less vulnerable to late season and harvest-time weather problems.

   Clearly, to me this continues to be a weather driven rally. Yes, supply/demand conditions are greatly improved and USDA's 2000/01 forecast is certainly encouraging but the likelihood still exists that the US will build stocks depending on the size of the crop. USDA's forecast of a 19 million bale crop is a long way from being made but if it is, it will likely put downward pressure on price as we get closer to harvest time. After that, we'll see what happens to exports and anything is possible.

   I think now growers have to evaluate the outlook, consider what risk they are willing to take, and look at alternatives for managing risk. In my opinion, the prudent thing to do would be to take advantage of the current rally by pricing at least some portion of your expected 2000 crop-- perhaps as much as 25%. But every grower will evaluate things differently and the important thing is to know where you stand and make the best informed decision you can. I'll admit it's a gamble no matter which way you go.

   The table below outlines just 4 of several possible strategies and shows the total price received for each depending on what happens to December futures. A range of 57 cents (pessimistic) to 70 cents (optimistic) is assumed. This analysis is further complicated by the A-Index. I am assuming the A-Index will be equal to the US futures price.... thus the numbers are on the conservative side (for much of this marketing year, US futures price was 3 to 5 cents above the A-Index). Also, the price shown does not include any "time value" of an Option.

   Deciding to hold off and make no marketing move at the present time can result in perhaps the best price if the market continues to move upward and reaches the 70-cent mark. It would result in the worst outcome, however, if prices were to fall. If prices were to decline, contracting would result in the best price but would result in the worst price if prices increase.

   Options appear to offer the opportunity to reduce risk although they may not result in the absolute best total price. These prices do not include any time value of the Option but time value would be small if the Option is held to near it's expiration date.

   So, what to do? To be brutally honest, it very much depends on whether or not a grower is willing and able to use Options. If, for whatever reason, Options are not in the picture then there is little difference between doing nothing and contracting at this point. HOWEVER, I agree with most other analysts and believe the odds of prices moving to 70 cents before harvest are less than the odds of falling back below 60 cents. So from that standpoint, I think some protection is warranted and I would tend to lean toward contracting. I wouldn't argue with anyone choosing to ride this "rally train" a bit longer provided they understand the risk, but I don't think we want to go into harvest completely unprotected.

   One of the problems or complications with contracting and fixing a price is that it presents a possible double whammy if prices move higher because there would likely be little or no POP payment. If a grower wants downside protection but wants to maintain the opportunity to benefit from any further move upward in price, the alternatives would include purchasing a Put Option rather than contracting or contracting then following up with purchasing a Call Option.

   Compared to doing nothing, purchasing a Put Option appears to offer better downside protection but possibly less upside potential. Compared to contracting, the Put offers a higher price if the market continues ti improve but less if prices decline. But Put Options can be useful to non-irrigated producers who want price protection but don't want to worry about guaranteed delivery.

   There is little difference between the Put Option route and Contract + Call Option. However, one advantage this alternative might have that is not reflected in the table is one of timing. If contracting then buying a Call, if the market moves up further this summer the Call will have "time value" also. The Option could be sold and a net gain realized and if prices then fell into harvest, the cotton would still get a possible POP payment.

   Options offer flexibility. If purchasing a Put Option, any value of the Put can be realized before expiration and the cotton POPed and sold, POPed and put "on-call", or POPed and sold and a Call Option purchased. The grower is under no obligation to deliver a specified number of bales.

   Growers should make their decision based on the odds of where the market will move from this point. Any rainfall in the Southeast or west Texas will likely depress price. Any weak signal on exports and foreign consumption will depress price. Eventually, the market may see a 7 as the first digit in price but it's too early to project that and as a grower I don't know if I would be willing to hold off until that day comes without some protection from prices moving in the opposite direction.

Don Shurley
Professor and Economist- Cotton
Dept of Ag and Applied Economics
University of Georgia

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