The 1998 crop year has been a brutal reminder that we operate in a global economy. The economic crisis in southeast Asia and more recently the devaluation of Brazil's currency have a negative impact on US cotton exports and prices and continue to create a cloud of uncertainty over cotton's future. Economic uncertainties are almost always bearish.

Currently, 1998 cash prices and 1999 prices basis the December futures are both well below the full economic cost of production for most cotton producers. Clearly, for many growers any profit made on the 1998 crop was the result of Loan Deficiency Payments (LDP or POP) of mostly 8 to 10 cents per pound resulting from low world cotton prices. This causes us to wonder (worry) about prospects for 1999.

The 1998/99 crop season thus far has been characterized by a sharply lower (compared to previous years) but a much better than expected US crop, declining US mill consumption and exports, resulting in better than expected forecast of US ending stocks, weak foreign mill demand, and improving supplies and stocks in exporting countries. We have also experienced an increase in imports of foreign textiles into the US.

According to USDA's January reports, the US crop is now 13.8 million bales (fully 1 million bales more than many thought possible just 3 months ago) and 1998/99 crop year ending stocks are now projected to be 3.2 million bales. Should mill use and exports not reach current USDA projections and the crop get a bit bigger even still, ending stocks could approach 3.5 to 4.0 million bales (yikes)!

Cotton production in key foreign exporting countries has changed little the past 3 years but world cotton demand has declined sharply- 85.1 million bales for 1998/99 compared to 89.6 million bales in 1996/97. Also, Chinese exports and stocks have increased this season but current low world prices have stalled the flow. As long as China has large stocks and a policy that could potentially put those stocks in the pipeline if the price is right, it may be hard for US and world prices to mount much of a rally.

Much has been made of the recent drying-up of Step 2 funds (which subsidize US exporters and mills and enhances US competitiveness when US price is above the world price). Without Step 2 funds, we have seen US futures prices driven to near world price levels- a move I thought was unlikely- but we have also seen an increase in the US crop which has contributed to the misery. But clearly the future direction of US prices will depend on the direction of the world price (A-Index) and 1999 US cotton supplies.

This year's price "stew" also includes factors such as foreign cotton imports into the US. Imports are expected to begin under Step 3 in late February or early March. This is due as much to the reduced quality of this year's US crop as it is price competition under the Step 3 formula. With the improved size of the US crop and with imports, it is hard to visualize reasons for a sustained rally in old-crop futures. The best prices for US cotton come when world supplies are tight, foreign demand is good, and US exports are brisk. Right now, none of that is in the picture.

Remaining 1998 Crop Situation- I believe current prices have already factored in all the negative news. Prices are discounted in anticipation of increased US crop size, continued weak exports, and pending imports. Thus we would like to hope that prices are now near the bottom although another 2-3 cent drop is possible on any further (unexpected) negative news. Chartwise, it's a long row to hoe back to the top. It look's like any recovery to the 63-64 cent area March futures would be an opportunity to unload some or all of any remaining crop. Any cotton not yet POP'ed should be. Cotton in loan should follow the same strategy as a cash sale. If cotton is below base grade, however, it will only be more difficult to find a home for it at a good price once imports begin. Holders of Call Options with a Strike above 65-66 cents may find it difficult to profit from them- but because of the decline in futures prices this strategy has still worked better than warehouse storage.

Looking Ahead to the 1999 Crop- December futures are currently in the 63-64 cent area. No cotton producer is ready to fix a price or floor with a contract or Put Option at this level. As previously stated, this is above variable costs but below full economic cost for most cotton producers and I would not encourage anyone to price at these levels.

Ironically, most observers seem to think that US cotton plantings may be equal to 1998 levels or actually increase in 1999- the price and profit outlook for alternative crops is as bleak or worse than cotton for many growers. Barring significant weather problems, this could potentially give us a crop in the neighborhood of 17 million bales or more- 3 million bales above this year. At present, there is no home (at a decent price) for 17 million bales of US cotton and December futures is already telling us that.

I have been asked if I think we will see POP payments again in 1999 (60-cent cotton would be a lot easier to swallow if we've got an 8-10 cent POP to go along with it). I think a 1999 POP is possible but I am nevertheless cautious. The POP, if any, is driven by the world price or A-Index... and the direction of the A-Index depends on many factors including world supplies and stocks. Among others, 2 factors could cause the A-Index to increase and the POP to decline (or disappear). If this year's low world prices would cause foreign acreage and production to decline, the A-Index would likely strengthen. But a reduction in foreign supplies could be offset by an increase in US production. So any increase in the A-Index may depend as much or more on improved world consumption to tighten supplies. Also, this year's level of world prices looks to be low by historical standards for supply conditions of the magnitude we have. We now believe that the direction of the A-Index is as much a function of who (what country) has the cotton as it is the quantity of the cotton itself.

The direction prices take this spring will depend in part on whether or not Step 2 funds are renewed for the 1999 crop year. This will require re-opening the farm bill. The availability of Step 2 funds would shore up '99 crop prices in the event US supplies are adequate and world demand is still weak. Price direction will also depend, to a lesser extent, on 1999 plantings. Eventually the market must reach a level that it feels will attract enough acreage and mills will need to begin to book their needs. With world demand weak and imports beginning in March, it could take prices a while to reach more desirable levels. I don't think December futures will move too much too soon- as this would likely result in overplanting. So be patient with marketing decisions. Right now 70-cent December looks to be the high mark but not likely anytime soon. Use of Put Options could be a very important tool for 1999.

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