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Recently, the United States repealed Step 2, which provides incentives for US cotton mills to purchase the commodity from US farmers. One of the most highly subsidized of all agricultural products, lawsuits by developing countries that cotton subsidies in America were destroying their domestic production forced the Bush government to take actions to satisfy the World Trade Organization (see Cotton and the WTO) What does this mean for the cotton investor? The answer is two-fold, and slightly more complicated than it may appear. Due to the recent legislation, US mills will now show no preference for where the cotton was produced. In the short term, this gives US mills a range of options that was previously unavailable. Many may begin to import cotton from Egypt, Brazil, or Turkey if the price is below what they have to pay for US Cotton. In reality, this is very unlikely, as US growers will drop their price to compete on the world market. Many US farmers will find that this price drop, however, will fail to cover their growing costs, and many will be forced out of business. While this initial price drop in cotton may last 1-2 growing season, eventually, the negative returns will cause the supply of cotton grown in the United States to decline. Once this occurs, The Commodity Investor will likely place a buy recommendation on the commodity, and the price may likely spike to over $.85/lb, from its current price of $.57/lb. In the short term, however, a decline below $.50/lb would not be surprising, and may be a viewed as a buying opportunity. While the repeal of Step 2 is a step in the right direction for free trade, the subsidies devoted towards cotton growing go much deeper, and leave developing countries unsatisfied with the change in policy. Many view the repeal of step 2 as a political maneuver that will hardly change the market's dynamics. While there exists no doubt that the majority of money used to subsidize this industry will still keep the price of cotton far below what the market would dictate, we believe there will be some mild effects from the repeal of step 2. The pressure on the United States will not decline however with this policy change, so it is likely that continued pressure will be placed on the US from free trade organizations and developing countries. This pressure may be an additional catalyst for the upcoming bull market in agricultural commodities. |
