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Opinion: two reasons to fear for far tighter cotton supplies

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Amid all the commentary on cotton markets, there are two key factors that have been overlooked and not fully understood.

The first are the realities of the Indian cotton balance sheet. The US Department of Agriculture is overestimating Indian ending stocks for 2011-12 by more than 5m (480-pound) bales.

That's what analysis of the country's own data tells us. The Indian government has said that the country's stocks at the end of last season had been lower than estimated by its Cotton Advisory Board due to larger export shipments.

These stocks, the starting point for 2011-12, are now at 3.3m (170-kilogramme) bales, which is lower than the 4.83m (170kg) bales estimated by the Cotton Advisory Board.

This means that the USDA should have to reduce its 2010-11 ending stocks number to 2.58m (480-pound) bales, from its current estimate of 7.60m bales.

Inventory overestimate?

Turning to this season, the Indian government estimate for the domestic crop has been adjusted down to 34m (170kg) bales, from the Cotton Advisory Board estimate of 34.5m bales. Also to factor in are exports of more than 10m (170kg) bales, but which could possibly could reach 12m bales.

The USDA currently has India's 2011-12 ending stocks at 7.95m 480-pound bales (or 10.2m 170kg bales).

If the USDA figure was correct, with such burdensome stocks, the Indian government would have never considered an export ban.

It has set a target of 5m (170kg) bales for inventories, although it now feels stocks will turn out much lower.

Questionable carryover

The USDA argument is hard to understand.

It presumes the Indian private sector carried a huge carryover into the 2011-12 season which seems an impossibility when logic is used.

The farmers and traders could not have handled the financial burden of carrying over 9.73m (170kg) bales into a season of collapsing prices.

It might be remembered prices were at a record and the government had banned exports at one time because of fears that It would run out of cotton.

Surging imports

The second factor that appears to be misunderstood by the speculative, managed fund and hedge fund sector is the impact of China's reserve purchases of cotton.

China's cotton imports in February reached 2.83m (480-pound) bales, or 616,000 tonnes, equivalent to more than half the expected 2012 Australian crop.

This reflected the second highest monthly volume on record, up 88.7% from January and 234% year on year.

The import volume reflects the need of Chinese mills to seek coverage through cheaper imported cotton, and the fact that the reserve has now purchased more than 2.8m tonnes of last year's domestic crop, equivalent to nearly 40% of the harvest.

This has removed much of the domestic high-grade supply. The reserve is set to have 4m tonnes or more in reserve stocks, this equals 29.5% of the total world stocks, on USDA numbers.

'Clearly misunderstood'

The speculative, managed money and hedge fund sector has clearly misunderstood the importance of the reserve purchases. This sector has appeared to view such stock building as bearish. Others have believed that the reserve will soon sell the cotton back into the market.

China's reserve programme is one of the best run and most astute attempts at national stock management in the world.

Across a host of commodities it has proved to be able to make intelligent market decisions in accumulating stocks when global prices are depressed and then releasing them to the domestic industry when prices rally, providing a major strategic advantage to the industry and increasing export earnings.

This was done successfully in the industrial metals during the global financial crisis of 2008-09 when copper and other industrial metals were purchased at very depressed prices.

Out of the market

China did the same thing with cotton during this period, as domestic prices collapsed during the 2008 crisis China purchased several million tonnes of domestic cotton.

It then released the cotton beginning in May 2009 and completely liquidated stocks by October 2010. The total volume released was 3.58m tonnes.

This season it prepared the warehouses and then began to purchase high grade domestic and imported cotton that could be stored well. It is very likely this cotton will be isolated from the world market until prices moved higher.

A move by world prices to above the reserve purchase price might trigger the release. Until then a release would be surprising.

Market squeeze

If a release is indeed not forthcoming then the marketplace is in for a shock - free world stocks will be at the tightest level on record by the end of the season.

It is clear New York's futures market and the textile sector does not fear this at all.

Ed Jernigan is global chief executive of Sydney-based Jernigan Commodities, which handles the marketing of cotton direct from large Australian producers

By Ed Jernigan

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