(Wu Faxin, General Manager of Hong Kong JKN International Group and Guangzhou icotton Ltd. E-mail: 852190803@qq.com)

The purpose of the stocking policy is to get prepared for wars, unexpected undersupply for the benefits of people. My personal understanding is that:
1) Preparedness for unexpected needs: to deal with the unexpected increase in demand, such as sharp increase in consumption of strategic materials due to wars.
2). Preparedness for unexpected undersupply: to deal with unexpected undersupply, such as sudden decrease in cotton output due to natural disasters. 
3) For the benefits of people: the reserve policy should benefit common people, not businessman or interest groups. 

However, what’s the situation today? Needless to say, you know it. 

Many believe that the price difference between homegrown cotton and foreign cotton will decrease as a result of the decline in prices of homegrown cotton and that foreign cotton will be no longer competitive. A common sense should be borne in mind that the price difference comprises subtrahend and minuend, C=A-B, where the price of international cotton B will drop faster if the price of domestic cotton A declines. The tremendous price difference C remains any way. Won’t the price of American cotton reach 60 cents/pound or lower? Why is that numerous Chinese cotton mills are trying to establish their presence in the US? A China Daily report provides the answer, that is, the cost s of homegrown cotton are three times those of American cotton as far as the planting costs and costs of seed cotton processing are concerned, and the potential of decline in the prices of homegrown cotton has not yet been fully unleashed. The price difference is here to stay if the quota control remains there. Imported cotton and yarn still have their shots, depending on how you will do. 

The recent discussion within a small circle in the industry is no longer whether the price of homegrown cotton will drop to 13000 Yuan/t, but whether the price of homegrown cotton will drop to about 10000 Yuan/t in the two cotton years of 2015/16 and 2016/17. At the first glance, you may think this is a gimmickry. but you might think seriously if I change the way I ask this question: will the cotton prices fall back to the 2008 level? In 2008, when both the industrial and commercial inventories were moderate, not to mention the 12 million-ton national cotton reserves, the proactive fiscal policy of the then government helped the economy reach an unprecedented climax, as the consumption was very strong at that time. A look at the continuous chart of cotton price trends finds that cotton price fell to 10080 Yuan/t on November 28, 2008. Let’s imagine, won’t the history repeat itself after new cotton pours into the market in October against the backdrop of a global huge harvest of cotton in 2014? Given the ongoing economic recession, the higher levels of inventories and lower levels of consumption, than 2008, this gives us no reasons to be unrealistically optimistic (the aforesaid viewpoint is purely my personal thought, not investment advice). 

According to related public announcements, as the destocking policy comes to end on August 31, 2014, cotton mills will face an embarrassing situation from September 1 onwards, as there is little marketable high-quality cotton resource on the market at present due to the three-year cotton stocking policy and the new cotton from Xinjiang will not reach the textile mills in inland China until the end of October, or 15 days later than that if the inspection and reporting process has to be completed before any shipment. If the destocking policy did not continue, there will be no cotton available for trade in the market during the vacuum period that will last 60 or 70 days. 

The vacuum period has little impact on major mills, which generally have several months of inventories of raw materials as backup and may take the advantage of this vacuum period to reduce the relatively high –priced cotton inventories before becoming capable to buy new cotton at a price of 14000-15000 Yuan/t with current funds when new cotton becomes available. 

But for smaller mills, it will be another story. As huge amounts of funds are required to purchase cotton reserves, possession of greater inventories would mean greater operating loss amid the price downturn of cotton, small mills generally buy cotton on a hand-to-mouth basis. But during the vacuum period, small mills will find themselves in an awkward situation where they can’t buy cotton when in need it. Where would small and medium-sized cotton mills secure their raw materials if they want to continue operation? The good news is that where there is a will, there is a way. I visited several companies and realized that small and medium-sized cotton mills may have the following choices:

First, use intensively the imported cotton quota acquired in the previous bidding process in September and October to address the undersupply of homegrown cotton to a certain extent, which will support the quotation of imported cotton in portside bonded warehouses to a certain extent in these two months 

Second, small and medium-sized mills purchase cotton through collective bargaining prior to August 31 and the quota received may be shared on a pro-rata basis and used in September and October, which may reduce the costs of cotton.

Third, switch to other varieties. Currently, the prices of adhesives have dropped to the five-and-half-year low, at 11500 Yuan/t, and the prices of polyester are very competitive, so are the prices of such substitutes for cotton as modal and bamboo fiber, which will seize a big market share from cotton fiber. The recently launched new-type polyester fiber as a highly imitated form of cotton will be mass produced, which draws much attention of downstream customers.  

Fourth, seek imported yarn in place of homemade yarn, as the low-count yarn is mainly imported from abroad and produced by overseas plants under OEM and packaged by overseas suppliers according to the packaging standard for homemade yarn due to its huge consumption of cotton. After customs clearance, these low-count yarns are sold as homemade yarn, thus retaining the customers. Imported yarn is sold on a 120-day L/C basis, in order to generate sufficient cash flow, which allows mills to purchase new cotton. 

Fifth, purchase cotton from lands not recognized by government. Since the government purchased cotton according to output in the previous three years, many cotton fields in Xinjiang were cultivated by landowners without the acknowledge of the local government, and were kept in dark from reporting and subsidization purposes. However, the cotton grown on these unlicensed soils have to be sold anyway, therefore the profit margins are generated. 

Producers reduce the speed of cotton consumption and production capacity or produce high-count yarns. 

Old wine in a new bottle. September and October are busy season of production, when the market prices of raw materials are relatively high. It is a good time to reduce the high-priced cotton stocks, sell more finished products for more cash and purchase new cotton after October with sufficient cash in hands.

Currently, the pricing power over bulk commodities including cotton around the world is in the hands of industrial and financial oligopolies in EU, the US and Australia. So far, China has four titles in terms of cotton value chain, i.e., the largest cotton producer with the largest cotton textile production capacity, the largest potential of cotton consumption and the largest potential of cotton market, all of which constitute a double-edged sword. But what China really lacks is the most critical weapon, the pricing power in the international cotton market. Without pricing power, China remains a world warehouse for the world factory and remains exposed to the largest risks of price fluctuation in the world.

It is predictable that the market price of new cotton will surely be lower than that of cotton reserves and the quality of new cotton better than that of cotton reserves. Cotton mills will definitely not buy and hoard more cotton before August 31 unless they have no choice. Just like a football game, only the side sure to win will run out the clock. Cotton mills will be blessed with prospect when the raw materials become abundantly available two months later, not to mention the National Day golden week, a good time for machinery maintenance. 

Amid the price declines, the most vulnerable player is the one at the highest stake. Private institutional investors have good reasons to hedge against such risk opening as early as possible, but both stocking and subsidization comes from public finance. Who cares?



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