The Start of Softer Cotton? – Rabobank's Australian Cotton Price Forecast

With a US-China trade deal now off the table, international cotton prices are in the doldrums – facing 32-month lows –as US cotton faces a particularly challenging demand outlook. In 2016/17, China purchased around 15% of US cotton – some 2.2m bales. With this demand now off-the-table for the foreseeable future, Rabobank forecasts the ICE #2 to trade towards USc 65/lb into late 2019 – in itself setting a negative tone for the Australian price outlook.

Trade wars aside, international prices will also come under pressure from increasing 2019/20 production across the US, Brazil, and India. This is set to raise world (ex. China) production to a record 98.7m bales, following strong relative crop margins and the hindsight of two very favourable seasons.

Stronger production will likely coincide with a weaker demand environment. As world GDP growth slows, Rabobank expects global cotton demand growth to stay between 2% to 3% next season, a far cry from the 6% seen in 2016/17.

The result is likely to be a swelling of exportable global stocks.

The good news concerns Australian basis. This premium for Australian cotton over the ICE #2 currently sits at an unseasonably high 1,500 points (equivalent to AUD 100/bale¹), driven predominately by rising demand from China – the world’s largest importer. Chinese buyers are already switching away from now heavily-tariffed US cotton, which should continue as China hikes 2020 imports a further 25% YOY(!). Closer to home, domestic drought also continues to support local basis.

Rabobank sees Australian market basis declining over the next 12 months, but only modestly.

We expect the basis to stay strong through Q3 2019 – averaging 1,200 points. It is likely to slip further with the arrival of Brazil’s 6m-bale exportable new crop (currently being picked) and as evidence of tepid new crop demand growth emerges. We forecast the basis to sink to 1,000 points as we enter the 2020 crop season in Q4 2019.

Local basis is, without doubt, the most volatile part of Rabobank’s Australian price forecast and is likely to experience considerable week-to-week swings.

Finally, domestic cotton prices will benefit from depreciation in the Australian dollar. We expect the currency to come under pressure as the RBA starts to cut interest rates, ahead of the Federal Reserve, on the back of downcast domestic inflation, a softer housing market, and concerns over both the current account deficit and the Chinese economy. We expect the AUD/USD to fall to 0.67 in the next six months, supporting prices in an industry which sees virtually all production bound for export.

Consolidating the above factors, Rabobank forecasts Australian cash prices of just over AUD 600/bale through Q3 2019. This figure is forecast to fall to AUD 560/bale in late 2019, predominately driven by weakness in both international futures and basis, as weighty 2019/20 supplies become available. Longer term, prices are set to touch AUD 576/bale by Q2 2020.

While suboptimal compared to the AUD 640 to AUD 650/bale prices seen through mid-May 2019, these prices still highlight a generally positive price outlook for Australian cotton – particularly where grower margins are concerned.

It’s worth noting that Rabobank’s fresh outlook for Australian cotton prices remains exposed to multiple risk factors. First and foremost, improving relations between the US and China pose significant upside risk to the ICE #2. While initially positive to Australian cash prices, this news could turn Chinese demand away from Australian cotton (towards the US) and inevitably pressure local basis and prices. Furthermore, crops remain exposed to global weather events – particularly US hurricanes, Australian drought, and Brazilian frost – which, once again, could pose significant upside risks to our Australian forecast.

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¹ 227kg bales as of 27/05/2019