MAKING SENSE OF COTTONS METEORIC RISE 20102011 Wally

MAKING SENSE OF COTTON’S METEORIC RISE 2010/2011 Wally Darneille April 27, 2011

BACKGROUND • AFTER MAKING A SHARP SPIKE TO AROUND $1. 00 PER POUND IN 2008, COTTON WENT TO ALL TIME HIGHS IN 2010 / 2011. • MAY 2011 FUTURES ON I. C. E. HIT $2. 20 PER POUND IN MARCH 2011. • DECEMBER 2011 FUTURES REACHED $1. 44.

WHAT HAPPENED? WHY? WHERE ARE WE GOING FROM HERE?

THE PERFECT STORM • FIVE STRAIGHT YEARS OF CONSUMPTION WHICH EXCEEDED PRODUCTION DREW WORLD STOCKS TO A DANGEROUSLY LOW LEVEL. • WORRIES ABOUT RETAIL SALES KEPT TEXTILES AND APPAREL INVENTORIES DANGEROUSLY LOW. • WEATHER PROBLEMS IN THE U. S. , CHINA, AND PAKISTAN HURT THE 2010 CROPS. • FINANCIAL INVESTMENT IN COMMODITIES BROUGHT HUGE LEVERAGE TO AN ALREADY BULLISH FUNDAMENTAL SITUATION.

Continuous Cotton Monthly NEW ALL-TIME HIGH 219. 70 Updated 04/14/2011

Continuous Cotton Weekly NEW ALL-TIME HIGH 219. 70 Updated 04/14/2011

JULY 2011 DAILY CHART Updated 04/14/2011

DEC 2011 DAILY CHART Updated 04/14/2011

COTTON HAS BEEN THE LOSER IN THE ACREAGE COMPETITION • SINCE ABOUT 1995, THE PRICE OF COTTON RELATIVE TO COMPETING CROPS HAS BEEN STEADILY DECLINING. • THAT’S WHY WE LOST ABOUT TEN MILLION ACRES WORLDWIDE TO OTHER CROPS. • WE “BOUGHT BACK” ABOUT FIVE MILLION ACRES IN 2010, BUT IT STILL WASN’T ENOUGH TO BALANCE SUPPLY WITH DEMAND. • WITH THE RISE IN 2010 CROP PRICES, WE WILL SEE INCREASED ACREAGE IN 2011.

Bushels / Bale Cotton Valued in Wheat 1975 to Present Updated 04/12/2011

Bushels / Bale Cotton Valued in Corn 1975 to Present Updated 04/12/2011

Bushels / Bale Cotton Valued in Soybeans 1975 to Present Updated 04/12/2011

COTTON GOT TOO CHEAP COMPARED TO OTHER STORES OF VALUE • THE FINANCIAL CRISIS OF 2008 REQUIRED MASSIVE INFUSIONS OF RESERVES AND GUARANTEES TO AVOID GLOBAL DEPRESSION. • LOOSE MONETARY POLICY MEANT HUGE AMOUNTS OF CASH STARTED LOOKING FOR INFLATION HEDGES.

Ounces / Bale Cotton Valued in Gold 1975 to Present Updated 04/12/2011

Barrels / Bale Cotton Valued in Crude Oil 1983 to Present Updated 04/12/2011

Index / Bale Cotton Valued in DJIA 1975 to Present Updated 04/12/2011

NEARBY COTTON VS. THE DOLLAR INDEX • GOING BACK OVER 25 YEARS, THE CHART OF COTTON VS THE DOLLAR INDEX SHOWS AN ALMOST PERFECT MIRROR IMAGE, OR INVERSE RELATIONSHIP. • HOWEVER, IN 2010, THERE WAS DIVERGENCE IN THIS PATTERN DUE TO THE SPEED OF COTTON’S ADVANCE.

Dollar vs. Cotton Dollar Cotton Log Scale Updated 04/12/2011

FIRST, A QUICK LOOK BACK • HERE ARE THE ESTIMATES FOR THE 2009 / 2010 CROP YEAR WE PRESENTED AT A BANKERS’ MEETING IN APRIL, 2010. • KEEP THESE NUMBERS IN MIND WHEN WE GET TO THE 2010/2011 CROP ESTIMATES.

USDA FEBRUARY ESTIMATES – WORLD SUPPLY & DEMAND 09/10 Beg Stocks Unkn. End Stocks to Use Prod Use MAR-10 62. 42 102. 24 115. 70 (2. 46) 51. 41 44. 4% APR-10 62. 75 101. 72 116. 07 (2. 51) 50. 91 43. 9% Change 0. 33 (0. 52) 0. 37 (0. 05) (0. 50) (0. 6%) Updated 04/13/2011

USDA APRIL ESTIMATES – WORLD SUPPLY & DEMAND 10/11 Beg Stocks Unkn. End Stocks to Use Prod Use OCT-10 46. 69 116. 68 120. 77 (2. 06) 44. 66 37. 0% APR-11 43. 99 114. 53 117. 12 (0. 15) 41. 55 35. 5% Change (2. 50) (2. 15) (3. 65) 1. 91 (3. 11) (1. 5%) Updated 04/13/2011

HOW TIGHT IS THE U. S. SITUATION? • THOUGH I. C. E. FUTURES ARE UNDOUBTEDLY INFLUENCED BY WORLD PROSPECTS, THE ONLY COTTON THAT CAN BE TENDERED AGAINST FUTURES IS U. S. COTTON, AND ONLY CERTAIN GRADES ARE ELIGIBLE. • SO U. S. CONDITIONS RULE, AND U. S. FUTURES CAN DIVERGE FROM WORLD PHYSICAL PRICES FOR THIS REASON.

USDA APRIL ESTIMATES – U. S. SUPPLY & DEMAND 10/11 Beg Stocks Export End Stocks to Use Prod Use OCT-10 2. 95 18. 87 3. 60 15. 50 2. 70 14. 1% APR-11 2. 95 18. 10 3. 70 15. 75 1. 60 8. 2% Change - (0. 77) 0. 10 0. 25 (1. 10) (5. 9%) Updated 04/13/2011

COTTON MAY BE EVEN TIGHTER THAN IT LOOKS • BEGINNING STOCKS MAY BE OVERSTATED. • EXPORTS HAVE ALREADY EXCEEDED ESTIMATES. • THE OLD CROP IS OVERSOLD • THE NEW CROP IS NOT OFF TO A GOOD START. • THE BIGGEST GROWING AREA IS IN TERRIBLE DROUGHT.

U. S. Exports Sales & Shipments as of April 7, 2011 2010 -2011 TOTAL SHIPPED TOTAL UNSHIPPED TOTAL COMMITMENT All Other 1, 585, 625 713, 646 2, 299, 271 Pakistan 306, 875 173, 438 480, 313 Korea 300, 208 254, 167 554, 375 Brazil 457, 396 181, 458 638, 854 Bangladesh 300, 104 372, 813 672, 917 Thailand 540, 417 180, 208 720, 625 Viet Nam 513, 854 216, 771 730, 625 Indonesia 639, 688 311, 250 950, 938 Mexico 857, 188 561, 771 1, 418, 958 Turkey 1, 506, 354 680, 521 2, 186, 875 China 3, 482, 500 1, 816, 354 5, 298, 854 TOTAL 10, 490, 208 5, 462, 395 15, 952, 604 Updated 04/14/2011

CURRENT SUPPLY / DEMAND OUTLOOK • WORLD PRODUCTION WILL BE LESS THAN CONSUMPTION AGAIN THIS SEASON. • WORLD CARRYOVER WILL BE DRAWN DOWN TO LOWEST LEVEL SINCE 1992. • WORRIES ABOUT WESTERN ECONOMIES HAVE LED TO DRASTIC INVENTORY DRAWDOWNS THAT LEFT THE PIPELINE EMPTY.

CURRENT SUPPLY / DEMAND OUTLOOK • PRODUCERS AROUND THE WORLD WILL INDEED RESPOND TO PRICE SIGNALS. • PRODUCTION SHOULD OUSTRIP CONSUMPTION IN 2011/2012. ’ • BUT FIRST WE HAVE TO PLANT THE CROP, PRODUCE IT, HARVEST IT, AND GET IT INTO THE PIPELINE. • THAT WILL TAKE UNTIL EARLY 2012.

COMPARISON OF ESTIMATES MY 2010/11 PCCA USDA Cotlook ICAC Production 113, 951 114, 533 111, 773 113, 215 Consumption 115, 610 117, 124 114, 299 114, 134 Balance (1, 659) (2, 590) (2, 526) (919) World Updated 04/13/2011

COMPARISON OF ESTIMATES MY 2011/12 PCCA USDA Cotlook ICAC Production 127, 081 127, 500 126, 833 126, 075 Consumption 120, 864 120, 000 121, 303 117, 532 6, 216 7, 500 5, 530 8, 543 World Balance Updated 04/13/2011

COMPLICATING FACTORS • CROP INSURANCE PRICE IS $1. 23. • CHINESE GOV’T (CHINA NAT’L COTTON RESERVE CORP) HAS ESTABLISHED A PURCHASE PRICE OF $1. 37 FROM SEPT 2011 -MARCH 2012. • THIS MAY ESTABLISH A “FLOOR” FOR WORLD COTTON PRICES AT ABOUT $1. 20 CIF CHINESE PORTS. • THAT MEANS $1. 04 FOB INTERIOR WAREHOUSE IN THE U. S. , OR ABOUT $1. 10 TO $1. 14 FOR THE FUTURES MARKET. • U. S. FARMERS WILL WANT TO DEFER INCOME UNTIL 2012, GIVING THEM AN INCENTIVE TO HOLD COTTON INTO NEXT YEAR.

CHINESE STRATEGIC STOCKS • CNCRC STOCKS MAY 2009: • SOLD MAY – DEC 2009: • SOLD AUG-OCT 2010: 4, 000 MM MT 2, 642 MM MT 1, 000 MM MT • BALANCE NOV 2010: 0. 358 MM MT • THIS EQUALS ONLY ABOUT 1. 6 MILLION BALES, OR 13 DAYS’ CONSUMPTION IN CHINA. Updated 02/19/2011

OTHER SUPPORTIVE FACTORS • DOLLAR WEAKNESS IS POSITIVE FOR COTTON PRICES. • THE ON-CALL POSITION IS HISTORICALLY VERY LARGE, AND VERY SKEWED TOWARD ON-CALL SALES WHICH REQUIRE FUTURES TO BE BOUGHT. • WORRIES ABOUT INFLATION HAVE MANY FUNDS LOOKING AT COMMODITIES AS AN INFLATION HEDGE, SO THEY’LL BUY AND HOLD. • CURRENT GEOPOLITICAL UNREST AND FAILURE TO HANDLE DEFICITS FUEL THAT DESIRE.

LONG-TERM SUPPORT • LONG-TERM GROWTH IN FIBER DEMAND WILL OUTSTRIP GROWTH IN FIBER SUPPLY, ACCORDING TO CCI’S EXPORT PROMOTION COMMITTEE. – DEMOGRAPHICS POINT TO SIGNIFICANT POPULATION GROWTH. – SYNTHETIC FIBER PRODUCTION TAKES TIME TO BUILD. – LONG-TERM TRENDS IN THE RAW MATERIALS FOR SYNTHETIC FIBER POINT HIGHER. – COTTON ACREAGE IS REACHING A PLATEAU, AND GROWTH IN SUPPLY WILL HAVE TO COME FROM GROWTH IN YIELDS. • THUS PRICES OF ALL FIBERS SHOULD TREND UPWARDS AS EXCESS CAPACITY IS ABSORBED. • CONSUMERS CONTINUE TO SHOW STRONG PREFERENCE F 0 R COTTON, ESPECIALLY AS INCOMES INCREASE.

MORE SUPPORTIVE FACTORS • DEMAND FOR COTTON IS STRONG OUTSIDE THE U. S. AND EUROPE. – OTHER COUNTRIES AREN’T AS INDEBTED AS WE ARE. – POPULATION GROWTH CREATES ITS OWN DEMAND. – INCOME GROWTH CONTINUES IN ASIA, AND FIBER CONSUMPTION SHOULD BENEFIT. • GLOBAL CONSUMERS ARE BEGINNING TO ACCEPT PRICE INCREASES ON A BROAD RANGE OF APPAREL PRODUCTS. • THE GLOBAL SUPPLY CHAIN SEEMS TO BE ABLE TO ABSORB COTTON PRICED AS HIGH AS $1. 80 BEFORE DEMAND DESTRUCTION OCCURS.

POTENTIAL PITFALLS FOR PRICES • ECONOMIC CONFIDENCE IS VERY FRAGILE, AND THE CONSUMER COULD EASILY GO BACK IN HIS SHELL. • THREAT OF RISING OIL AND FOOD PRICES COULD PINCH OFF CONSUMER SPENDING. • EMPLOYMENT GROWTH HAS NOT BEEN SIGNIFICANT, AND FISCAL RESTRAINT WILL SLOW DOWN THE AMOUNT AND VELOCITY OF MONEY. • SYNTHETIC FIBER PRICES ARE WELL BELOW COTTON, AND FIBER SUBSTITUTION IS OCCURRING. • COTTON SUPPLIES SHOULD REBOUND IN 2011/2012.

CONCLUSION • COTTON PRICES ARE PROBABLY GOING TO FIND A NEW MEDIUM-TERM EQUILIBRIUM LEVEL THAT WILL BE A GOOD BIT HIGHER THAN THE 60 -CENT RANGE OF THE 19902009 PERIOD. • OUR BEST GUESS FOR CURRENT CROP IS $1. 50 - $2. 25. • FOR NEW CROP IT’S $1. 00 - $1. 50, DEPENDING ON WEATHER. • IT WILL TAKE WELL INTO Q 1 2012 FOR PRESSURE TO BE OFF OF SUPPLIES AND PRICES.