COTTON: RECORDS, RECORDS AND MORE RECORDS

Subtitled: The Good, The Bad and The Truly Extraordinary

This year cotton has been nothing short of amazing given all the records tested if not broken, new ones made and new records projected. (Slide 1) Whether it is in the US, World numbers or individual countries such as China, the 03/04 crop year will be known as one filled with records. Some of them are considered positive such as hitting new record high yields in 7 US states including the Mid-South region. The quality of the current US crop achieved a new standard with 75% of the upland crop tenderable, the highest since the early 1980’s and US exports are officially estimated at 13.2 million, a new all time high if achieved. Depending on your bias with prices, the current projection for China to import more cotton this year than any other could be viewed in either light given its impact on prices last fall. (Slide 2) By the same token, China’s consumption will top all previous records, not good news for US mills and textile manufacturers. In the next 30 minutes, we will examine these records and what they mean for US producers for the remainder of the 2003/04 crop year and the upcoming 2004/05 season. Given the overwhelming impact that China has and still is having on US fundamentals and prices, I will begin my comments with China; move next to the US and then on to the World situation. Then we will take a quick look at cash and futures prices from a historical perspective and discuss the activities of the USTR as they affect you. Finally, I will reveal our ideas regarding fundamentals and prices for the next 6 to 18 months.

Over the last 20 years, China’s role in the international cotton market has been extraordinary due in large part to the huge swings in its’ raw cotton imports and exports. Massive changes in Chinese trade were directed at managing ending stocks because government policy was unable to quickly and successfully match production with consumption each year. (Slide 3) The result was carry-out levels oscillating from very low such as in the early 1980s to very high in the mid 1980s, back down in the early 1990’s only to rise to excessive levels in the late 1990’s and finally off again into this decade. For instance, in 1989 Chinese ending stocks hit a 20-year low of 3.98 million with a stocks/usage ratio of 20%. By 1998, they had increased by more than five fold to a new all-time record of 23 million with a ratio of 123% only to fall again to the current estimate of 6.8 million with a stocks/usage of 21%. The draw down in cotton ending stocks over the last 5 years is directly linked to a surge in Chinese cotton consumption that has escalated since 2000 by more than 10% per year. The jump in their consumption is attributable to an expanding middle class increasing domestic textile consumption at the retail level. However, the majority of their burgeoning textile production was for the benefit of the export market. Textiles provide employment and are highly profitable due to cheap labor and a fixed currency. China has been very successful in penetrating retail markets in developed countries and especially in the US in preparation of 2005 when the remaining quotas on US textiles are removed. The Chinese currently accounts for 31% of global cotton usage compared to 22% only 6 years ago. Put another way, at 30.5 million bales, China will consume one out of every three bales of world usage at 97.2 million bales per the USDA. The above-mentioned record level of carryout in 1998 of 23 million allowed Chinese mills to utilize domestic stocks with limited imports to cover the deficit between production and consumption until this year, when their luck ran out.

This crop year began with expectations of Chinese production of 27 million due to a 22% increase in area and the assumption that yields would remain near last year’s record high of 1176 kgs/hectare. (Slide 4) However, precipitation was above normal overall especially during August, September and October, critical months for the boll development and opening stages. Some key cotton-producing provinces recorded more than 200% of average. In addition, the more favorable rainfall totals through the entire season raised river levels leading to greater widespread flooding than usual. Per a FAS/PECAD report updated Jan 13, “examples of low boll counts, boll shedding, wilting, late development, pests and diseases, and low quality were widely reported. According to crop surveys conducted last fall, yields are down 10-50% from last year in most cotton-producing areas”. Based on this and other information, the USDA began lowering their Chinese crop estimate of 27 million last fall. In this month’s supply and demand report, yields were finalized at 956 kgs/ha, down 19% from last year’s level and the lowest since the CY1996/97. This reversal of fortunes reduced production by five million bales to 22 million bales; a number still considered high by some private and public analysts who are using a figure much closer to 20 million. The National Statistical Bureau, China’s counterpart to our USDA, weighed in on the issue last month by maintaining their earlier estimate of 22.4 million bales. As one of my favorite TV chefs says “it does not take a rocket scientist to do the math”, consuming more than 30 million bales while only producing 22 million, or less, can lead to only one result, massive record imports by China. In calendar year 2003 and last crop year 2002/03, the US market share of Chinese raw cotton imports was 60-61%. Based on their need for not only huge volumes but also better grades of cotton, the US is an obvious fit given this year’s much higher quality crop.

Continuing on our theme of records, one of the most explosive and hotly debated topics is this year’s projected US exports of 13.2 million, 1.2 million more than last year’s record and 2 million more than the previous year of 11.2 million. (Slide 5) In 1994, US exporters shipped 9.4 million but prior to that year, the last record in place stood for more than 7 decades, in 1926 exports totaled 11.3 million bales. China should account for as much as a third of this year’s US exports with Mexico, Indonesia and Turkey taking up another 30-35%. Filling in another 25% may not be too difficult either; it is the last 10% that has some traders feeling vexed and apprehensive. Over the last two years, unusually high levels of sales and shipments occurred in the second half of the season. In 2001/02, the increased volume was due to multi-decade low prices and an abundance of low grades that could be further discounted. In 2002/03, unusually large certificates that increased US competitiveness, a second year of poorer quality growths availability, and additional demand, specifically from China, helped boost US exports. Of these three reasons, China is the best chance for helping reach the official target should they import more than forecast as prices are substantially higher than the last two years and the certificate values in turn are much lower on average. Currently, another 3 million bales must be sold and shipments are lagging. More on this topic later.

Part of the US demand structure is domestic consumption though far less now than only a few years ago. In 1997/98, US mills consumed 11.35 million but this year that figure will be cut by almost half to 6.2 million due in large part to pressure from foreign textile imports with China leading the charge over the last two to three years. Perhaps another sub-title for this presentation would be “A Tale of Two Countries” given the reciprocal if not what some might describe as parasitic relationship that exists between the US and China. Unfortunately, this change of events is proving to be a permanent one especially in light of the additional pressures on margins that US mills will experience in 2005 forward. Despite the loss of domestic usage, US total demand this year estimated at 19.4 million will be the second highest if realized, and only 1.2 million behind the 1994/95 record of 20.6 million.

Moving to the US supply side, here too, records were set right and left or better put, east and west of the Mississippi River. This year, no less than 7 states and one region enjoyed record upland yields including every state in the Mid-South, La, Ms, Ark, Mo and Tn, along with Ok and Ks. (Slide 6) In 2002/03, Texas and California, breaking their previous state records, helped push their respective regions, the Southwest and Far West to new records. Since 2000/01, when NC also sustained a new high yield, 10 of the 15 major states have seen their old yield records fall. Finally, not to be left out, the Southeast region did sustain its third highest yield on record this year all of which generated new records for upland cotton of 719 lbs/ac, a gain of 14 lbs over the previous record of 1994. Pima performed almost as well this year. It could not overcome its 2002/03 record of 1342 lbs/ac but did manage to squeak by the 01/02 level of 1254 lbs/ac with its second best performance of 1257 lbs/ac. All cotton yields registered a whopping 725 lbs/ac, 9% above last year and the 5-year average and topped the previous record by 17 lbs. On the opposite end, 2003/04 all cotton acreage at 13.48 million is the second lowest in 10 years although that is not how the season began. A year ago, US producers indicated their enthusiasm with cotton with intentions of planting 14.2 million acres but adverse weather dictated otherwise. (Slide 7) Despite the lower area, the push to new high yields helped the US produce 18.225 million bales, the 5^th largest crop in history and second highest since 1998. Adding the above average carry-in to this year’s crop pushed supply to its third highest level since the mid 1960’s. The net effect of high supply into near record demand is helping lower ending stocks to 4.25 million, below the last 3 years but above the 11-year average sustained during the 1990’s decade of 3.47 million bales. However, as we all know, absolute numbers do not always paint an accurate picture. If we view this demand and carryout via the stocks/ usage ratio of 21.9%, we find it is half that of 2000 and 2001, at an eight-year low and only slightly higher than the 1989-1999 average of 20.5%. Having reviewed the fundamental picture for China and the US, let us now turn to their influence on the world supply and demand situation.

The US and China contributed 44% to the world’s production this year, 38% of global usage and account for 34% of current estimated stocks. That leaves more than half to two-thirds in the hands of countries such as India, Pakistan, the CIS group, Brazil, the African French Zone, Turkey, Indonesia, Thailand, Mexico, Bangladesh and Greece to name only a few. It is well documented that world consumption has surged to new highs in the last few years thanks in large part to China. Prior to the start of this crop year, a new record was predicted but the impact of high prices very early in the season forced the USDA to trim their estimate for 2003/04 to this month’s 97.2 million, 900,000 bales below the record established in 2002/03. Outside of China, consumption has been stable or stale depending on your interpretation. (Slide 8) In the first half of 1990’s, world usage excluding China ranged from 64 to 66 million, advanced to 66 to 69 million in the second half of the last decade and averaged 68.5 million from 2000 through 2002. In 2003, a reversal is occurring with world usage ex-China at 66.74 million, the lowest level since 1998. In direct contrast to the US and in line with China’s expansion, Pakistan and Turkey have made significant gains in their consumption growth in the last 5 years. India, Brazil, and Indonesia have remained near their 5-year averages, unlike those countries in the remainder of the world. Besides meeting their internal demand for textile products, many of the above mentioned countries compete with China for textile exports with varying degrees of success. Currency fluctuations have helped some while hurting others in their attempt to increase revenue derived from textile trade depending on whether their goods are priced in local currency, US Dollars, Euros, etc. (Slide 9) This topic, in and of itself, could easily take up this entire speech and its complexities baffle the most astute economist. What I can tell you is that part of the difficulty for you and me in understanding the effect of currencies on world cotton and textile trade and therefore global consumption of both stems from the US Dollar weakness vs major developed countries or regions compared to other currencies. Much of what we hear and see regarding the US Dollar weakness applies to its relationship with Europe’s Euro, the British Pound, Australia and Canada’s Dollar and Japan’s Yen. However, the US Dollar has lost little ground against many Asian countries such as India, Hong Kong, Thailand, Taiwan, South Korea and China when comparing rates from Jan 3, 2000 against those as of Feb 6, 2004 per the Federal Reserve’s New York district website.

Many of these countries either have their currencies pegged, or fixed, to the US Dollar such as China. Others allow movement, but only within a narrow ban effecting holding their currencies artificially low. An excellent tool for displaying true movement in the US currency is the Real Exchange Rate Index published by the Federal Reserve. The NCC displayed this chart in at their annual meeting and never was the phase “a picture is worth a thousand words” more appropriate. Paraphrasing the NCC comments, this index compares the dollar to a weighted averaged of currencies of Other Important Trading Partners excluding major developed economies. Mexico carries the largest weight, followed by China, South Korea and Taiwan. The index shows a dramatic rise in the US Dollar in 1997 and 1998, additional gains in 2001 and 2002 before leveling out in late 2003.

The currency that has attracted the greatest publicity of late versus the US Dollar is China’s. Efforts by the White House to convince the Chinese government to float their currency have thus far met with stony resistance. Chinese exports of all goods, not just textiles, enjoy a particular advantage over other countries because its currency is held lower than it should be making its products much cheaper. Trade data released last week by the US Commerce Department showed the deficit with China was close to $124 billion, a new record. It is this benefit plus the huge difference in labor costs that continues to bring such pain to US mills and speaks volumes as to the difference in profit margins compared to our own.

Moving from World usage to crop size, records abound here as well. The year began innocently enough with area of 32.9 million hectares, very close to the 10-year average and 2.4 million above that of 2002. (Slide 10) Coincidentally, the 30.5 million hectares planted worldwide in 2002 was the third lowest on record with 1986 the lowest at 29.4 million. For those of you not involved in cotton in 1986, futures prices briefly broke below 30 cents the year before just as they did in the fall of 2001 influencing producers’ decisions to avoid planting cotton the following season. On the flip side, 1995 saw the largest planted area with 35.9 million hectares, a point to remember when we discuss possible area this coming spring. Yields proved to be a disappointment but not one that should have been too much of a surprise given the records achieved the two previous years. Last year, global yields were the second best on record at 630 kgs/ha, only 2 kgs less than the all time high achieved in 2001 of 632 kgs/ha. Despite record or near record yields in the US, India, Turkey and Brazil, the 2003/04 world yield of 612 kgs/ha was off 2.7% from 2002, nearly the same as the 5-year average of 611 kgs/ha but 18 kgs higher than the 10-year average. The result of average area and yields was just that, an average crop of 92.7 million bales, considerably less than earlier ideas but still the fourth largest on record. The above-mentioned record yield of 2001 also produced a record world crop of 98.5 million, another point to keep in mind. (Slide 11)

The 2003/04 crop year began with beginning stocks at a 7-year low of 36.7 million bales. When combined with 92.7 million bales, supply fell short at 129.4 million bales, the lowest level since 1996’s of 127.4 million. The end result is now obvious, when we subtract the second largest global usage, ending stocks are falling to 32.49 million bales, well below the previous 8 years and only 2.6 million bales or 8% higher than the 1994/95 level, the year that prices breached the dollar level.

Before I conclude my discussion of fundamentals for the remainder of this year and next and therefore futures price trading range, a quick review of where prices have been in recent years and why is needed. This will help put in perspective the current bullish supply and demand situation and whether the same will hold true for the next year and a half.

Since 1990, the nearby futures contract has traded as high as 117.20 in April 1995 and as low as 28.20 in October 2001, both of which are multi-decade if not all-time records. (Slide 12) The Cotlook A Index, a composite of quality cash growths throughout the world, posted similar records of 117.98 and 34.97 during the same time frame. The next 8 years were all down hill for futures with one exception, a quick, hard rally to 83.30 in July 1998. From 1994 to 2001, several milestones occurred, more than a third of the US domestic industry was irrevocably lost, China’s mill usage increased proportionally to new records, US exports approached previous records, world production continued rising overall but stumbling on occasion and US and world ending stocks ran the gambit of extremes. From a macro view, the raw cotton market has had to contend with the fallout of the 1998 Asian currency crisis, hyper gyrations in US and World stock markets, huge swings in key currencies including the US Dollar and a new geopolitical environment after the 9-11 terrorist attack. (Slide 13)

All of this brings us to the 2001/02 crop year when US stocks ultimately reached a level only exceeded by the 1985/86 level and World endings stocks were their third highest on record. As harvest approached in 2001, raw cotton supplies were becoming increasingly abundant relative to projected consumption and, as markets do, US cotton futures began to drop in an attempt to stimulate demand longer term. From the early 1980’s forward, with the exception of 1985 when a radical new farm bill was introduced, US futures have held at or near the 50-cent level consistently year in and year out. (Slide 14) However, the supply and demand tables for that year would prove to be too much for cash and futures and when coupled with the overwhelming economic uncertainty surrounding the horrific events of 9-11, US futures broke through the 50 cent level and eventually found support just over 20 cents lower at 28.20, only a few ticks below the 1985 low. The A index suffered a similar fate falling to a monthly value of 37.35 in October 2001, a loss of more than 24 cents from only a year earlier when the October 2000 value was 60.90. Eventually the A index’s annual value for the 2001/02 season would collapse to 41.88, a new record low.

Conventional wisdom proved correct, the low prices that occurred in the fall of 2001 set the stage for the next two years by reducing production via less area and boosting consumption to the 2002/03 record. From 2001/02 to this year, per the USDA, US stocks are down 42%, World carry-out is off 31% and its stock/usage ratio rivals that of 1994/95. From Oct 2001 to Oct 2003, US futures tripled in value from 28.20 to 84.80 with the A index jumping 227% from 34.97 to 79.29. This is the official version; now we will talk about what really happened with US futures since the crop year began.

It is important to understand there was a combination of factors and events that contributed to the 44 cent rally of the last two years and more specifically, the 30-cent gain over a period of 10 weeks last fall from late Aug until late October. During August and into September, weather conditions in China went from bad to awful to truly horrendous with their cotton crop and surprisingly, news of those troubles was freely disseminated. China was already seen as a major importer of cotton given how low their carry-in was this year. Rumors of even higher levels of imports began to sweep through the international and US markets fueled in part by the rapid run-up in Chinese cash and forward prices on the CNCE and C-Index. (Slide 15) In mid-August the USDA pegged the US crop at 17.2 million, a figure that would prove to be 1 million bales shy of the final figure. US exports at 11.8 million and US ending stocks of 4.3 million left little room for a sizeable jump in new exports without pulling US carry-out down to a very tight level. Shortly after the USDA released their supply/demand reports on August 12, a pre-harvest low of 54.30 basis the October 03 contract was made on Aug 22, 2003. During this time, the specs and funds were carrying a modestly long position of 9.6% with 5,833 net longs and 29,000 gross longs with futures open interest just over 60,000 contracts. Into early October, their percent long would escalate to new records of 50.3% with net longs of 54,610 and gross longs of 77,467. In their September, October and November supply and demand reports, the USDA made the much anticipated and unprecedented changes to the Chinese crop, US exports and World ending stocks. By early-mid October, the specs and funds were at a saturation level and futures had advanced by 15 cents but the next 3 weeks would see the market rally another 15 cents due entirely to China. With very little cotton already bought from foreign suppliers and the quality and quantity of their crop rapidly deteriorating, China made an unparalleled purchase of nearly two million bales from US exporters in the last 3 weeks of October. Those US exporters who made the sales hedged themselves in the US cotton futures and/or options markets buying the equivalent of 20,000 contracts. In the second half of October, only 40-50% of the US crop had been picked keeping harvest pressure to a minimum. With few sellers in the futures market, prices exploded hitting a high of 84.80 basis the December 03 contract on the last day of October just surpassing a high of 83.30 made by the July 1998 contract in July of that year. During this entire rise with futures, the options market underwent a metamorphosis like that never seen in cotton including the spring of 1995 when futures broke through the $1.00 level. Key players, some spec and some commercial, were using options to hedge their futures position, allow market movement participation, protect against adverse price movement for customers, etc. You and I may never know exactly who or why the options trade skyrocketed as it did but the spillover from the options activity was integral in the futures rally. The NYBOT exchange confirmed the record options activity for 2003 with 2,157,441 contracts, most of which traded in the second half of the calendar year. Not to be left out, US cotton futures open interest would also set a record high of 116,633 contracts the week ending October 24, 2003. (Slide 16) We now know that by the end of October, the specs and funds were holding huge longs, the trade had just initiated a massive long hedge position and with the US and other northern hemisphere crops leaving fields and moving into warehouses, the inevitable market correction occurred. A quick, hard and massive drop of nearly 20 cents throughout the month of November unwound with several move-ending limit down sessions on or around the Thanksgiving holiday. Here too, options may have exacerbated the sell-off as speculators and hedgers sought to liquidate and then reverse their long positions. Since early December, US futures and options trading have been much more sedate although several shorter but no less volatile moves have transpired. During all of this, the A index experienced similar manic moves. While futures were rallying 30 cents last fall, the A index advanced by more than 19 cents or a 32% increase. Unlike futures, the A had only lost 7 cents from late October to mid-December giving many bullish traders reason to maintain their friendly outlook for futures. All of this brings us to how cotton prices may trade the remainder of this crop year and into 04/05 based on our perceptions of fundamentals but first, there is one last issue to cover that is important.

It would be remiss of me if I failed to touch on the various trade agreements being pursued by the USTR on behalf of the White House. They affect each of us and in ways that may not be apparent at first blush. (Slide 17) Starting in 1988, a free trade agreement was implemented with Canada. Shortly afterwards, Israel and Jordan were added to mix. The North American Free Trade Agreement, better known as NAFTA, which brought Mexico into the agreement with Canada, was next followed by Chile and Singapore. In addition to FTAs, there are preferential trade agreements such as Caribbean Basin Trade Partnership Act that encompasses most of the Caribbean region and is vital to many American mills. As a part of the Trade and Development Act of 2000 is AGOA, the African Growth and Opportunity Act enacted for Sub-Saharan countries. The USTR originated a PTA with 5 countries in South America, Colombia, Ecuador, Peru, Bolivia and Venezuela called the Andean Trade Preference Act. ATPA was later amended to, are you ready, the Andean Trade Promotion and Drug Eradication Act. It is just what it sounds like, if this area of the world will cease the production and selling of illegal drugs, we grant them preferred status to US markets with products such as textiles. In all of these, country of origin and yarn forward rules are included in some fashion as protection against an influx of textiles that are “duty-free”.

Besides the agreements already in place, the USTR has completed FTA negotiations with Australia and the controversial Central American Free Trade Agreement or CAFTA. Congress and the President have not yet formally signed both but various cotton and textile organizations including NCC and ATMI are fighting for revisions to CAFTA. Significant loopholes exist to the yarn-forward rule of origin rendering them ineffective in protecting US mills. This agreement began with 5 countries, El Salvador, Honduras, Nicaragua, Guatemala and Costa Rica. Now, Ambassador Zoellick wants to include the Dominican Republic increasing the size of CAFTA by 40% and making CAFTA countries the second largest US trade partner in Latin American behind Mexico.

The USTR is also negotiating with Morocco and SACU, short for South African Customs Union, which is made up of five countries in the southern tip of Africa. Negotiations are to begin shortly with the Kingdom of Bahrain and their GDP is 133^rd in the world, hence, any benefits to us with this country are lost on me. Finally, free trade agreement negotiations are planned for Thailand, Panama, Colombia, Peru, Bolivia and Ecuador. In the midst of all of this are efforts at arriving at a Free Trade Agreement of the Americas. The FTAA would encompass 34 countries in the western hemisphere stretching from the Artic to Antarctica. By now, you may be thinking why is this an issue for me as a producer because surely as a consumer I am benefiting.

The impact to you is two-fold: First, the enormous increase in textile imports since the Asian currency crisis is directly related to the nearly 50% loss of American mill consumption. In the late 1990’s, two of every three bales were consumed domestically with exports considered a wild card to total demand. The various trade agreements combined with the ongoing 10-year schedule to remove US textile quotas that resulted in an extraordinary increase of textile imports since 1998 has decimated your largest customer.

In the last 3 years, exports and domestic consumption have reversed roles with two out of every three bales you produce going to overseas mills. Here is where the second influence comes into play. The cotton cert program, vital to US exports, is now under attack. In an attempt to jumpstart the WTO negotiations, Ambassador Zoellick announced in a recent letter sent to trade ministers of member countries, the US is committed to eliminating the subsidy component of export credit programs. Cotton is specifically referenced, meaning in other words, the cotton cert program is being offered as “the proverbial sacrificial lamb”. In this same letter, the USTR also stated support for cuts in trade-distorting domestic support for agricultural products including cotton and we all know what that means concerning the farm program long term. Sounds like progress run amuck to me.

Turning to fundamentals and prices through July 2004, production in the northern hemisphere is close to its final figure. Weather in the southern hemisphere, while not perfect, is considered generally acceptable for making a world crop of 92-93 million bales. With the supply side of the equation answered, the market focus is now on demand and more specifically, will it meet its projections. Cotton consumption is considered inelastic in that it is slow to move in response to market events. (Slide 18) One clear example is the movement in usage a year after a major price change so readily seen in 3 separate circumstances since the mid 1990’s as discussed earlier. Cotton consumption can also be compared to a freight train, slow to start up but when maximum speed is achieved, very difficult to slow down. That is the situation we find ourselves in currently, international cash and US futures prices are at their highest level in several years and manmade fiber prices are cheaper; the impact on global consumption, excluding China, is and will be negative, if only marginally. As for China, reports regarding their consumption is mixed with business confidence surveys suggestive of a slowdown due to the shortage of capital, unprofitable margins during 2003, lack of quality cotton, high prices for available cotton and weakness in yarn offtake and prices. Yet, NSB yarn output data by Chinese mills from August through January show an increase of nearly 11% from the corresponding period of 2002/03. Figures for December 2003 pointed to a 17% year-on-year gain from 2002 but January 2004 data is off 5% from January 2003. The question many are asking is which is the anomaly. My suspicions are that it will take several months if not into the start of 2004/05, before official figures show a decline in usage outside of China with Chinese growth merely restrained and without the double-digit expansion enjoyed of late. World cotton consumption should come in closer to 96 million bales rather than the USDA estimate of 97 million bales with a nearly unchanged figure into 2004/05. If correct, then slightly less usage should in turn impinge on trade and lower prospects for US exports by 3-7%, hence our figure of 12.5 million versus the USDA’s of 13.2 million. The price break that occurred in late January and spread into this month allowed US exporters to sell upwards of 1 million bales and further sizeable sales are likely assuming cotton prices cooperate and China completes their anticipated purchases of US styles. (Slide 19) Shipments, though, are another matter, as weekly levels in each of the remaining five and a half months must average 299,000 bales, a feat only accomplished twice in two crop years and only then 8 times in 2002/03 and 7 in 1994/95. The recent 10-week average of shipments of 248,000 which includes the traditional time frame when shipments are heavy is well short of that needed in the last 25 weeks if the USDA estimate is to be reached. Many merchants have indicated their confidence in reaching the official target but new trucking rules and difficulty in obtaining space on cargo ships may hamper their efforts. Further complicating merchants’ efforts is the ongoing lack of a certificate. In published news reports, the missing certificate is not seen as interfering with scheduled shipments but if current price differences that forced the certificate to be dropped are continued beyond the next several weeks, merchants may be further taxed in meeting the required level of shipments. The importance of the final level of US exports is clear when we consider the direct and immediate impact on our ending stocks. If 13.2 million is shipped by Jul 31, ending stocks will fall to 4.25 million. However, if shipments slip by only 500,000 to 1 million, US ending stocks will rise to 4.9 to as much as 5.5 million; similar to that of 2002/03’s of 5.4 million bales.

Switching to world ending stocks, at 32.4 million bales, they are uncomfortably tight although this low level is in large part due to China’s smaller crop and textile expansion. Even if global cotton consumption does ease off a bit, world prices as reflected by the A index are unlikely to lose much through the third quarter of this marketing year and possibly the fourth until confidence builds regarding new crop potential in the northern hemisphere. In the US, historically speaking, when futures explode upwards in the fall as they did this year and then fall back, any subsequent highs are lower highs with lower lows over the course of the season. At this late date, very few if any expect futures to breach 80 cents, we now merely find ourselves arguing over whether they can re-test the low to mid-70s basis the May contract before succumbing to new crop pressure. Beyond this spring and into early summer, if China’s additional purchases easily exceed market expectations from current levels, and no other problems are presenting themselves, the July 04 contract could get a boost but exceeding the highs made since January 1 with the March or May 04 contracts may be difficult. The high quality of this year’s crop provides an additional outlet for merchants looking for a home for some of their inventory meaning they can move more to the board. By early/mid June, the weight of burdensome certificated stocks is likely to either force additional carry in the market or lower prices in order to find a commercial taker.

As to possible downside activity, much will depend on whether US shipments are maintaining their needed pace and if planting progress in the northern hemisphere and specifically the US is proceeding normally I.e., if weather is cooperating (or not). If the current support in the low/mid 60’s is taken out and I think it will be over time, the May and/or Jul 04 contracts should find support every 3-5 cents down as the market stair-steps lower. If the old crop months violate the 60-cent area, futures may simply grind lower through the summer with a pre-harvest low above the loan level. I suspect many of you as producers will be less than happy with these lower prices but they increase the likelihood that you could receive a portion of your counter cyclical payment in 2004/05. That is if futures, and therefore cash, trade in a more subdued fashion into this coming fall and beyond.

Looking into next year, almost everyone including the private and public sectors anticipate higher cotton area in the US and overseas. (Slide 20) The International Cotton Advisory Committee, the National Cotton Council, Cotlook, Inc. and many industry leaders are forecasting an increase in US and foreign cotton plantings due to this year’s much higher prices. The NCC released the results of their US producer survey at their annual meeting three weeks ago indicating US acres would soar from this year’s 13.483 million acres to 14.795 million, a whopping increase of 1.276 million acres or 9.5%. By way of explanation, this multi-segmented cotton group stated in their economic release “from Jan 2, 2003 to the end of 2003, the A index rallied from 56.50 to 75.45 or a gain of over 18 cents”; hence, their forecast for a jump of 10 million bales in global production from the current 92.7 million to 102.3 million in 2004/05. The ICAC pointed out in their most recent monthly update that international prices have not been this high this time of year since 1997 explaining why their global area is up 1.72 million hectares or 5.3%. With a 3.7% increase in yields, this organization is estimating a world crop of 100.9 million bales. This same organization also has US area up almost 10% but both the ICAC and NCC see only a slight improvement in US production as yields return to trendline. The PECAD division within the Foreign Agriculture Service arm of the USDA will release their forecast for cotton foreign area on Thurs, Feb 19 during the USDA Outlook Forum. Closer to home, the National Agriculture Statistical Service will release the results of their farmer surveys for US cotton, Wed, Mar 31. In regard to world production, both figures listed above would be a new record and the arguments in defense of those projections are compelling. My own world crop estimate is just below theirs at 98.5 million and at the same level as the previous record set in 2001. (Slide 21) Soybeans could prove to be more competitive with cotton than reflected in some of the other forecasts and until more is known, I prefer to be conservative with cotton area. The same can be said in the US as our projection is for 14 million acres, a gain of 3.9%, and assuming normal abandonment and yields closer to average, a crop near 18 million bales is likely.

As to the breakdown by country with world production, China is expected to make the largest jump with their crop but Australia and Pakistan should also see significant recoveries. Brazil’s long-term ability to increase production over the next several years is nothing short of amazing and the high quality of their cotton will prove stiff competition for the US, CIS group, French Afr Zone and Australia. (Slide 22)

Switching to the other side of the fence, demand, I expect only marginal increases with new crop world consumption, if any. China may enjoy modest gains in their pursuit of Jan 1, 2005 but the rest of the world may not unless prices are appreciably lower. Our projection is 97 million bales for 2004/05, up 1 million from our estimate for this year and near the mid-point for the two-above mentioned groups’ forecasts. In all three instances, global ending stocks are seen growing; the only question is by how much. If world carry-out approaches or exceeds that of 2002/03’s of 37 million, although low, they would not be nearly as tight as this year’s. The ICAC has been and continues to project a lower annual value for the A index into next year of 59 cents compared to the current estimate of 71 cents. The impact on futures should be similar with generally lower prices across the board especially into this fall if indeed a new record crop has to be “put to bed”, hedged by producers and merchants and then later sold into foreign markets. Thus far we have talked very little about the “Technicals” of US cotton futures and I am not going to start now other than to say those whom I listen to and provide guidance indicate calendar year 2004 should see a substantial drop toward the mid to low 50’s and possibly high 40’s. Into the second half of the marketing year, much will depend on foreign demand for US cotton with our focus directed at China. Assuming the Chinese do make a crop much closer to 30 million, they are still seen importing sizeable volumes of cotton to re-build stocks and bridge the availability of cotton between crop years. How much they import and in particular from the US along with other countries’ needs will be critical to the size of US exports.

As with this year, how much or how little the US can move into overseas channels will have a direct bearing on its ending stocks. Even if US merchants can move 11-12 million bales, a super figure any other time, US ending stocks are likely to grow and possibly by as much as 1-2 million bales. US mills will be unable to help in this effort, as they will be under fire with the removal of all US quotas half way through the marketing year. Looking out over the next 4-6 years, by some accounts, US usage may fall to 5 million, merely a skeleton of its former strength.

Beyond this next crop year, US cotton faces many challenges with little relief likely from textile imports and increased foreign production competing for world trade. Yet, more raw cotton will be needed to meet record demands for this natural fiber as the world economy grows and new uses are found for cotton. As consumers, we will greatly benefit from the changes sweeping across the world of cotton and textiles. As citizens of this country, the premier and dominant role we have enjoyed in the world of cotton and textiles is fading and may continue to fade. (Slide 23)

Since I began my comments with China, I will conclude with China. The Chinese have been incredibly successful in penetrating US markets and monopolizing market share of various products. Using official 2002 US trade data, their market share with bicycles was 80%, 70% of lighting and 95% of rubber-soled shoes. Prior to Jan 1, 2002 when apparel quotas in 29 categories were lifted, China’s textile imports were very small accounting for 11-16% of US market share per the American Textile Manufacturers Institute. In the last two years, China’s imports have surged increasing by 85% in 2003. The Chinese now supply 19% of the US textile and apparel import markets and in the apparel categories where quotas were removed, China gained a market share of 55% in less than 2 years. China is now twice as large as the next largest supplier, Mexico. Per projections from the ATMI, by the end of this calendar year, China will account for 77% of market share in the quota-removed apparel categories and you can be sure they are gearing up to do the same in the remainder of the categories after next January.

China cannot take over the world ideologically as they have wanted to since the Communist Party overran the Mainland right after WWII; they appear bent on doing so economically 50 years later. The ATMI has forewarned its membership that if China is left unchecked, they will all be out of a job. This past week, the loss of US jobs came to the forefront in the national media due to comments made by a White House official and in a report from the President. Perhaps we too should re-examine our priorities as consumers because at some point, our jobs, our livelihood, and possibly our way of life may be at risk. That statement may sound melodramatic but we have record deficits that are being funded by foreign investment, white collar jobs in the service sector are the latest victims of our open door trade policy and stability in the geopolitical environment remains ever elusive.

In the world of cotton, it is no longer a matter of planting, growing, harvesting a crop, and then marketing it as prior generations have done. We are all members of a global community, one that requires more of you than in the past. The records made recently in cotton will undoubtedly continue. My hope is that they will be more positive than negative for our industry. Thank you for allowing me to share our views on these very important issues for each of us.