There are so many questions remaining about the current crop that it seems crazy to be talking about 2019. But for planning purposes, it’s never too early to be thinking about opportunities and risks. To begin with, the (uncertain) size of the 2018 crop will influence the supply of next year’s balance sheet in the form of carry-in stocks that could exceed 4.5 million bales.
Then there is the question of 2019 production. Cotton prices have been relatively good during 2018. This might contribute to at least as much, if not more, cotton acreage planted in 2019. History suggests that when corn futures prices are this low in relation to cotton futures (presently a ratio of 5.1), we could expect cotton planted acres between 13 and 14 million acres (see the graph below).
The weather in 2019 is a major consideration, as it always is. NOAA is currently forecasting an El Niño watch, with a 60% chance of wetter-than-normal conditions during September-November , increasing to 70% during the winter. This is consistent with the wetter September that we have already observed. This raises the possibilities of soil moisture accumulations, lower abandonment, and higher yields for spring-planted crops in the drier regions of the Cotton Belt.
With at least average U.S. yields and abandonment, planting 13.5 million acres could produce a 21 million bale crop, which implies a very healthy supply of 25+ million bales. Even assuming an increase in U.S. exports above 2018/19 levels, it would be easy to increase ending stocks under this scenario. Increasing ending stocks year-over-year is historically associated with price weakness. It has been a while since we’ve had futures below 70 cents, but I at least want to remind readers of the possibility of downside price risk.
What can be done about this situation? First, go into it with your eyes wide open, knowing the expected per unit costs of production that you must cover if you are going to plant cotton. Second, consider the risk of hanging on to unsold 2018 bales. Third, consider pricing or hedging some 2019 cotton earlier while prices are still relatively high.
For example, on September 20, 2018, Dec’19 settled at 76.05, having declined two cents earlier in the week (see the blue line in the chart below). A 75 put on Dec’19 cost 4.5 cents (see the red line below), implying a short futures position at 70.5 cents per pound. A 75:68 put spread on Dec’19 ICE cotton cost 2.82 cents per pound (the green line below), which would protect against the risk of Dec’19 falling from 75 to 68 cents. Such a position held into early 2019 represents insurance against a decline in the base price of 2019 crop insurance policies. The premiums for this insurance might become even more affordable during brief rallies this fall.
In other words, act quickly to implement a strategy like this if there is a rally in the futures market. Another obvious prerequisite for a strategy like this is establishing the necessary brokerage relationships and accounts, not to mention pre-planning the orders. It will be too late to do this when the market is briefly 2 cents higher after an unexpected development. And it will likewise be too late if the market is 10 cents lower next Spring.