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Debate on cotton prices missing killer question

The debate about cotton prices is missing the killer question.

OK, the contrast between broker forecasts is of more than academics interest. Rabobank, for instance, said on Thursday it believes New York futures are in for a firm finish to the year, ending at 85.0 cents a pound.

On Friday, Commonwealth Bank of Australia took a more downbeat view, seeing them ended 2013 at 70 cents a pound. CBA cited "burdensome" stockpiles, which are set to end 2012-13 at the equivalent of some nine months supplies a record high.

A gap of $0.15 a pound represents quite some value when the world is expected to have more than 39bn pounds of cotton on tap even before getting to this year's harvests.

Big question

But the real issue is why cotton prices are anywhere near these levels at all.

The record levels of supplies imply that prices should be at historic lows, meaning perhaps below 40 cents a pound, as last reached in late 2008.

The reasons they have remained well above this level are not all reassuring.

Rising costs

One good reason for cotton prices not to revisit past lows is that production costs have risen.

Variable costs for US producers are some $543.42 per acre, according to North Carolina State University. That is some 18% above 2008 levels.

Agricultural commodities tend to be supported, in times of glut, at levels where it becomes more economic for farmers in major producing countries to go on holiday than keep on growing.

In sugar, traders cite growing costs of production in Brazil, pegged by Rabobank at close to 20 cents a pound for many mills, as one reason why prices of the sweetener have not fallen back below 18 cents a pound despite increasing ideas of the world production surplus.

China's tricky position

But some other reasons look less secure.

Take China. It has had a huge impact on world supplies, not just through its stockpiling but its farm support programmes which have involved buying the fibre at $1.30 a pound or more to support domestic growers.

China will not want to take any action to reduce the value of its huge inventories. But it does not appear to have a strong hand.

Especially if, in 2013-14, it near halves imports to 7.0m bales, as Rabobank predicts, so removing a huge demand from international markets, but doing nothing to erode China' cotton mountain.

One extreme to the other

But that assumes, of course, that published estimates have a decent grip on Chinese data.

Another reason cited for cotton prices remaining relatively high is scepticism that supplies of the fibre are indeed as rich as these numbers suggest.

"People can't figure out how we went from historically tight stocks, which drove prices to all-time highs, to record stocks so quickly," Keith Brown at brokerage Keith Brown & Co said.

If markets are teasing out the truth on supplies, as they often do, especially when it comes to China's non-transparent supply dynamics, then there may indeed not be nearly as much cotton in the world as commentators suggest.

That is worth any investor in cotton thinking about if they believe the question over cotton it whether to bet on prices rising to 85 cents a pound, or falling to 70 cents a pound.

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