QUESTION B2 Cotton Price Unravels (Alexandra Wexler, The Wall Street Journal, Ju

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QUESTION B2 Cotton Price Unravels (Alexandra Wexler, The Wall Street Journal, July 27, 2014) Cotton prices have retreated to the lowest level in nearly five years as investors worry that global production could overwhelm demand for the fiber. The U.S., the world's biggest cotton exporter, is expected to produce a large crop in the season that begins Aug 1. But global demand is likely to fall short, especially with top importer and consumer China wrapping up a 212-year stockpiling program. the amount of cotton left over in warehouses world-wide when the next season ends will reach an all-time high of 105.7 million bales U.S. government forecasters predict er years of drought, Texas has begun to see rain in cotton-growing areas. Government forecasters, citing the rainfall, recently increased their estimate for U.S. cotton output during the 2014-15 season by 10% to 16.5 million 480-pound bales, exceeding market expectations for a 4.7% upward revision to June's estimate. There are also concerns about weakening demand. The International Monetary Fund recently cut its global economic- growth forecast for this year to 3.4% from an April estimate of 3.7%, damping sentiment in the cotton market. Cotton prices are particularly sensitive to economic data, because demand for the fiber is tied to consumer spending on items such as apparel, bed sheets and towels.' a) Using a supply and demand diagram, explain the effect of the changes outlined in the article on the equilibrium price and quantity traded in the US cotton market. Assume that the US market for cotton is perfectly competitive (5 marks) b) The US Government has traditionally provided support to the cotton farmers through a comprehensive set of production subsidies. Cotton farmers are eligible for direct and counter-cyclical payments. Using a supply and demand diagram, explain the impact of a per unit production subsidy scheme on the market and welfare outcomes for the industry. Who is likely to gain and who is likely to lose from this scheme? (10 marks)

Explanation / Answer

C O T T O N M A R K E T R E P O R T 1 www.reinhart.com May 31, 2018 ICE Cotton No2 Futures Dec18, daily 75 77 79 81 83 85 87 89 91 93 95 May 18 Apr 18 ICE Cotton No2 Futures most active continuation, daily 65 70 75 80 85 90 95 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 ICE Cotton No.2 - On the heels of a once again extremely strong ZCE market, ICE cotton futures exploded to the upside with shorts scrambling for cover. Every single month from Jul18 to Jul19 was locked/trading at limit-up for pretty much the entire session on Monday. The fact that outright futures trading was difficult or not possible, triggered massive interest for options (over 50’000 lots traded) on that day as participants had to find ways to protect, adjust, liquidate or initiate positions. In addition to the well-known key bullish drivers (e.g. the adverse weather conditions in West Texas and the extraordinary amount of speculative buying interest at ZCE), issues related to existing futures and options positions became evident. This week’s action saw prices trading to new four-year highs. Back in March 2014 through May 2014 the area around current highs represented a key retracement and resistance field. Technical picture: prices are currently in overbought trading conditions. However, this alone does not mean much as markets can stay in overbought territory for quite a while. Important is to watch out for multiple and significant price vs. momentum oscillators divergences. Nearest important support appears to rest between about 89.00 and 88.00 (basis Dec18), followed by 86.50-86.00. Settling and building value below 86.00 signals a move to around 83.00. Shortterm key resistance is between 92.00 and 93.00. If broken, 95.50 becomes minimum up-side target. (continue 2nd page) ZCE Cotton Futures Jan19, daily 15500 16000 16500 17000 17500 18000 18500 19000 19500 May 18 Apr 18 May30 May23 change ICE No2 Jul18 92.49 86.96 5.53 ICE No2 Dec18 90.85 84.02 6.83 ICE No2 Mar19 90.18 83.60 6.58 ICE No2 Jul18-Dec18 1.64 2.94 -1.30 ICE No2 futures o.i. 306'930 297'140 9'790 ICE No2 certified stocks 74'143 77'225 -3'082 A-Index 17/18 100.70 94.90 5.80 ZCE Jan19 18'805 17'675 1'130 MCX Cotton Jun18 22'170 21'230 940 USD Index 94.069 94.003 0.066 C O T T O N M A R K E T R E P O R T 2 www.reinhart.com May 31, 2018 ICE Cotton No.2 (continue) - Whether the market experienced a blow-off type action this week remains to be seen. The huge volume that traded yesterday is certainly a key component of identifying such. In recent history, similar large volume days marked either important (temporary or lasting) highs or lows. However, more evidence is needed, such as a vicious pullback from the current top which is followed by a lackluster counter rally. USA – It is going to hit 105 F° today in Lubbock, TX. Cotton is being planted but most of the dry land farmers do not expect to make a crop. Lack of widespread moisture coupled with extremely high planting temperatures unfortunately is a recipe for disaster for the largest growing area in the United States. According to yesterday’s soil moisture report all of district 12 has short to very short topsoil moisture AND subsoil moisture. The bulk of the acreage in WTX is located in this district, in 2017 the district accounted for 60% of the WTX acreage and 56% of the production. Famers have all but written off their dry land acreage and are having a hard time keeping enough moisture on the irrigated acreage. Actually, famers may only water ½ a cycle on the pivot irrigation fields. Of course, this will increase the abandonment substantially if this happens on a large scale. There is already concern that irrigated farmers could run out of water. With such high temperatures this early and no topsoil or subsoil moisture it is nearly impossible to keep enough water on the fields. Contracting for new crop is heavy this week thanks to the record high prices of ICE Futures. Farmer in Texas may have a prudent approach to sell forward, but in fact Memphis/Eastern farmers/ginners are taking most profit of this current drought situation in West Texas. The storm Alberto had some minor impact on the crop in Memphis territory. The planting is well underway in this region. India – Cotton prices traded firm on w-o-w tracking gains in the overseas market. Indian Meteorological department (IMD) reported that rainfall over the country for the 2018 monsoon season is most likely to be normal and quantitatively the rainfall will be 97 percent of the long period average with a model error of +/- 4 percent. As per the latest report by the Ministry of Agriculture (India), cotton planting reached to 0.782 million hectares till 25 May’18, down by about 30.4 percent as compared to the same period of last year. Lower availability of irrigated water supplies in Northern states kept the planting at slow pace. Export demand for current crop was witnessed from Far-East, Pakistan and Bangladesh market. Cotton 29 mm MCX (June contract) broke the important resistance level of 21’400-21’450 and set new contract high at 22’630 during the week. Immediate resistance is seen at 22’580-22’630 and support at 21’700-21’750. China – After a short pause the ZCE cotton market broke out of a bullish consolidation pattern and set new contract high at 19’250, basis Jan19 contract. Open interest continued to climb up and reached this week a new historical high at 1.37 million contracts. The market looks extremely overbought, however, there is no clear signs of topping yet. Nearest meaningful support area comes in at 18’200-18’000, critical support is at around 17’000. The higher ZCE led also to higher physical prices. Reserve sales continue at a 100% pace and prices also increased over 1’000 RMB/ton (over 7.00 c/lb). Xinjiang cotton from the reserve is also above 17’000 Yuan/ton (converted to T328). Early this week, Mills bot some physical cotton from the reserve as well traders who are not fully following ZCE. A lot of physical buying for Xinjiang crop emerged as people can hedge in ZCE at a pretty good basis. Rumors said China will soon issue additional import quota to meet its commitment with US to open up for more agricultural products import. However, this has not brought any pressure to the domestic market yet. The information in this report is provided solely for informational purposes and should not be regarded as a recommendation to buy, sell or otherwise deal in any particular investment. Private customers should not invest in these products unless they are satisfied that the products are suitable for them and have sought professional advice. All information in this report is obtained from sources believed to be reliable and we make no representation as to its completeness or accuracy. The information may have been acted upon by us for our own purposes and has not been procured for the exclusive benefit of customers.

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