China and India. Both grow more cotton than U.S. growers. And there is huge production in Pakistan, South American countries and elsewhere.

No wonder U.S. exports slowed and cotton prices stayed stagnant for growers at or near government loan level.

But as has been seen with corn, price trends can change quickly. Crop shortcomings in these big producing areas, especially China — which produces 25 million bales — can create better markets for American growers like Billy Sam Borchardt, who also manages Top of Texas Gin, Hereford, TX.

Besides making a crop with his brother, Joe, he must worry about getting cotton processed for gin customers, as well as helping them market their crops when opportunities to secure a good price arise.

“Marketing has been stalled because prices have been too low,” says Borchardt, whose gin is part of a small network of independent gins under the Windstar tag in northwest Texas.

“In the past, our Windstar Pool worked with growers to help them lock in good prices during the growing season and make it available to them at harvest — when they needed it,” he says. “But in most of 2006 and 2007, we have seen prices mostly below the 52¢/lb. loan rate. There just aren't many marketing opportunities.”

With breakeven levels of 60-65¢/lb. or even higher, government payments are a must to make up the difference in low prices and high input costs.

When the market is there, a typical Windstar Pool program sees growers agree to market a portion of their acres with the gin. The expected production from those acres is pooled with others in the program. When prices are attractive, say in the upper 60-70¢ range, the pool fixes a price for a portion of the pool cotton.

“In the program, we try to have all of the cotton priced by mid-October,” says Borchardt. “In good pricing years, we may have 10 fixes during the season.”

That money is made available to growers in the pool at harvest and is not spread out in smaller payments throughout the following year.

In most seasonal marketing years, prices climb in the spring and summer, before falling at or near harvest. In such cases, growers in the pool have much of their production priced at the better markets, then have access to their loan deficiency payments (LDP) when prices fall back toward the loan level.

“Many farmers want to concentrate on producing their crop and leave the marketing to our pool when it is active,” says Borchardt. “We are just waiting for the prices to go high enough for us to offer it to them.”

December 2007 cotton futures were in the 56¢ range this spring. But in mid- and late summer, markets pushed the 66¢ level. A rally in September, like the one in July, was attributed more to speculative overdrive than to traditional supply/demand fundamentals, says John Robinson, Texas A&M University cotton marketing economist.

As such, it may prove volatile. However, it has driven cotton futures back to potentially hedgeable levels for growers.

“The uncertainty about if/how high this speculative drive will climb highlights the importance of flexible hedging strategies such as put options,” says Robinson.

December 2008 cotton futures were in the mid-60¢ range in September, an indication that better prices may be in the forecast.

This spring, U.S. cotton exports were projected at up to 13.5 million bales, slightly lower than expected. USDA also lowered projected U.S. domestic use to 4.95 million bales. With the lower total use, forecasted U.S. 2006-2007 stocks-to-use is 9.20 million bales.

The bottom line suggests a large 25% increase in 2006-2007 U.S. stocks-to-use, relative to the previous marketing year, says Robinson, adding that the marketing of last year's crop was hamstrung by low exports and shrinking domestic use.

However, with the U.S. 3-million-bale reduction, tight foreign supplies and the impact of any production problems, countries will likely prevent their stock from going any lower, he says. “So if an Indian monsoon is too much or too little, or China has a production problem, there could be an upside reaction.

“Prices could go higher and an options strategy should be considered by growers,” Robinson says. “If anything happened and the market rallied, I would step in with options and maybe hedge part of my expected production by buying some puts.” With rallies to 62-64¢, growers might be able to hedge in a pretty good floor.

Another direction would be to forward contract cotton, either through a pool or directly with the gin. “Then I would think about possibly buying call options,” says Robinson. “That would provide protection against a rise in prices at which your cotton is forward contracted.”

For example, if a rally enabled a grower to forward contract cotton at 64¢, he could consider a 72-74¢ call that could add to the contracted price. “You would be covered both ways,” says Robinson.

“But I would expect those rallies to be short lived. I wouldn't linger. I would do something to set a floor on a good rally. And if a grower fears that a lengthy rally might reduce his government counter-cyclical payment, he could consider buying call options to protect the CCP,” he says.

Robinson notes that if and when rallies take place, options premiums and volatility may be higher, meaning growers could face higher costs for price protection.

Borchardt says that when the Windstar Pool is active, growers are encouraged to consider putting one-third or one-quarter of their cotton production in the pool to spread their risk.

“A grower can put one-third in the pool, sell one-third and leave one-third open at harvest to wait for a better rally,” he says. “That way you split your risk.”