Cotton futures rose again on Thursday, April 15th, following a week of rising prices. May 2021 cotton futures finished at $0.8502, up 0.82% on the day and 3.98% on the week. July 2021 cotton futures finished at $0.8626, up 0.75% on the day and 3.92% on the week. December cotton futures finished at $0.8308, up 0.56% on the day, and up 2.36% on the week.
Despite a weaker export sales report than anticipated, cotton prices still rose. The USDA Export Sales Report, representing the week ending April 8th, showed net sales at 122,300 RB. It also showed net sales were down 55% from the previous week and down 54% from the prior 4-week average. This poor export sales report was the only thing holding back prices from surging even higher, as the pattern of the past couple of days has indicated.
Prices have been rising steadily this week, following good economic data and worsening drought conditions across much of the U.S. West and West Texas. More economic data released on Thursday (April 15th) suggests that the U.S. economy is beginning to heat up. The Commerce Department reported that same Thursday that U.S. retail sales in March climbed to a seasonally adjusted 9.8% compared to the month prior. The rise in retail sales was likely due to people finally receiving and spending their third set of stimulus checks from Biden's $1.9 trillion stimulus package earlier this year, combined with people having a generally better outlook on the U.S. economy.
More good news came from a weekly initial jobless claims report that was also released Thursday. These initial claims reports were expected to be over 700,000. However, the report showed that initial jobless claims were at 576,000 for the week, which was the lowest since the pandemic.
All of this good economic data is great for cotton prices for two reasons. First, good economic data suggests the economy is returning to its state pre-pandemic. Meaning, more consumers will be buying more goods, including cotton-based products. Therefore, demand for cotton will increase prices. Second, as the economy heats up, inflation fears once again arise. Many people will shift their investments into commodities during high inflation times because prices often stay grounded much more in reality than consumer products. Both of these factors help contribute to the fantastic turnaround of pricing from the month prior.
Worsening drought conditions across much of the U.S. West are limiting yield expectations for this year's crop, decreasing supply, and raising prices once again. Especially in West Texas, which is the largest production area of U.S. cotton for the whole country. The recent U.S. Drought Monitor report showed no improvement for drought conditions across West Texas and California's Central Valley, which are both cotton hubs, over the past week. Drought conditions are expected to worsen as the West's rainy seasons end and the hot and dry summer begins.
The Monthly U.S. Drought Outlooked released on March 31st, which is valid for April 2021, projects droughts to persist in these areas for the rest of the month. If drought conditions continue to worsen, we can expect prices to continue to rise. Traders and textile companies alike should keep their eye on these weekly drought monitor reports. On the horizon for the May 2021 cotton futures is their expiration date.
Next, we will explore how this may affect prices.
How do commodities contracts' finite nature influence prices near expiration?
Cotton futures and other commodities are finite in nature. Meaning, you can't trade them in perpetuity because they have expiration dates. Therefore, this tends to influence their prices near their respective expiration dates because most commodity futures traders are not looking to purchase the quantities of the specific commodity. Instead, traders hedge against or with the commodities market.
Trading tends to be more volatile near the expiration date of commodities contracts. Traders will look to roll over their interests to another month to avoid the associated costs and obligations associated with the settlement of a contract. If a trader does not roll over their interests in the commodities futures market, they can settle their contract in two ways. First, they could physically settle the contract by physically receiving the goods they paid. All the while, money is taken from their account. The other way they could settle the contract is a cash settlement. In a cash settlement, the price of the contract is either debited or credited to the holder's account, depending on if the contract resulted in a profit or a loss.
As discussed, most traders do not want to settle these contracts. Instead, traders rather roll over their interests to another month to maintain their exposure in the market. So, in the coming weeks, as the May 2021 contract begins to near its expiration date, traders should look to see these prices become more volatile as traders move to roll over their interests to another, later contract.
When contracts expire, there are usually a couple of days between when the last day of trading is allowed on the contract and the actual expiration date. May 6th, 2021, is the last day of trading on May 2021 cotton futures contracts. Traders should look for prices to become increasingly volatile as that date comes near.
Where are cotton prices headed?
In the short term, we can expect cotton prices to rise. While economic conditions improve and drought conditions worsen, this will continue to pull demand and supply in directions that cotton bulls see as favorable. Additionally, rising crude oil prices, which are now almost at a 4-week high, are also helping drive cotton prices higher in the short term as transportation costs rise.
We recommend keeping an eye out for new economic data that could provide insight into the state of the recovery of the U.S. economy. The data will give a market-wide view of how prices might move in the short term. Additionally, keep your eye on the U.S. Drought Monitor report that is released every Thursday. The report provides valuable insight into growing and planting conditions in cotton hubs, especially as planting season across the South and West begins to ramp up in other places.
As always, our projections for cotton futures prices were made using exponential smoothing with an alpha value of 0.5 to reflect the fast-paced changes in the market that can happen at a moment’s notice. A higher alpha value allows us to put more weight on more recent data points, therefore causing them to affect our projections more than data points from long ago.
Figure 1. The expected future market price of cotton by May 2021.
Figure 2. The expected future market price of cotton by July 2021.
Figure 3. The expected future market price of cotton by December 2021.