The Chinese reserve policy began (or greatly expanded) in 2011 and continued through the 2013 crop. It basically operated like a traditional price support program: The Chinese reserve announced a high support price at which growers sold their cotton. The government reserve held this cotton off the market, maintaining an artificially high internal price.
Analysis from USDA in early 2013 suggested that China’s stock policy might be part of a more enduring price support and rural development/security policy that would not likely end anytime soon. That analysis was reinforced when the China Cotton Association repeated a government announcement that their domestic price support policy would continue for the 2013 crop (at roughly $1.50 per pound). Later in 2013 there were signs of potential unwinding of the Chinese stockpiling policy. The first evidence of this was a lower volume of domestic Chinese cotton being purchased for the government reserve. By September 2013 with the arrival of new crop supplies, it was noted that Chinese cotton imports were down 23% year-on-year. As of the end of October, China had only purchased 59% of their domestic cotton compared to what they had purchased by that time in 2012. Part of the reason for this is higher quality standards that were imposed in 2013, restricting the amount of cotton that could be purchased. The new quality standard was being interpreted by some as evidence of a broader change in the policy, and perhaps aimed more generally at market oriented reforms. More evidence of a cotton policy change came in October when China stopped buying cotton when prices dipped to the supposed support levels in the lower 80s (basis Dec’13 futures).
In 2014 there was an announcement of a clear policy shift from the price support/accumulating bales policy to paying growers a direct cash payment. The policy is reminiscent of the shift in U.S. farm policy in the 1970s to target price/deficiency payment approach. However, depending on the level of the target price, such a policy can still distort markets and create surplus supplies. For example, if China pays growers the difference between a high target price and currently low market prices, and then growers sell their cotton at the low market price, the implication is that Chinese buyers will consume more of the low priced domestic new crop — hence cutting into the demand for exports. Such a possibility apparently led to bearish expectations and market weakness during 2015. Like all Chinese cotton policies, the new target price subsidy ia part of a larger and complicated combination of measures. For example, the Chinese control how much foreign cotton can be imported at a favorably low tariff. On September 22, 2015 they announced that they were only offering the minimum amount of duty-free import quota. In so doing, China was using another policy lever to increase demand for their domestic cotton at the expense of imports. The main impact of this policy evolution has been clear: Chinese imports have shrunk 40% per year for two straight years.
This graph shows a futures spread of old crop cotton (i.e., the most active Mar’15), to the deferred new crop contract, the Dec’15. The scale of the graph is in cents per pound. It is calculated as the Mar’15 futures price minus the Dec’15 futures price. Spread relationships fluctuate every day as the futures contracts trade. They are often interpreted as indicators of commercial bullishness or bearishness. If the spread is a negative number (which it currently is), it reflects the normal situation of higher deferred contact prices reflecting the cost of storing cotton. If the spread was a positive number, it would reflect an inversion. Inverted spreads might indicate a near term shortage, a near term increase in demand, and/or a relatively more bearish view of the future. Since my outlook for the 2015 cotton market is somewhat bearish, I expect this old crop: new crop spread to narrow and perhaps invert as time goes by. Either that, or I will eventually realize that my 2015 cotton outlook is wrong.