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

1. MAKING SENSE OF COTTON’S METEORIC RISE 2010/2011Wally DarneilleApril 27, 2011

2. 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.

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

4. 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.

5. Continuous CottonMonthly NEW ALL-TIME HIGH 219.70 Updated 04/14/2011

6. Continuous CottonWeekly NEW ALL-TIME HIGH 219.70 Updated 04/14/2011

7. JULY 2011 DAILY CHART Updated 04/14/2011

8. DEC 2011 DAILY CHART Updated 04/14/2011

9. 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.

10. Cotton Valued in Wheat1975 to Present Bushels / Bale Updated 04/12/2011

11. Cotton Valued in Corn1975 to Present Bushels / Bale Updated 04/12/2011

12. Cotton Valued in Soybeans1975 to Present Bushels / Bale Updated 04/12/2011

13. 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.

14. Cotton Valued in Gold1975 to Present Ounces / Bale Updated 04/12/2011

15. Cotton Valued in Crude Oil1983 to Present Barrels / Bale Updated 04/12/2011

16. Cotton Valued in DJIA1975 to Present Index / Bale Updated 04/12/2011

17. 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.

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

19. 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.

20. USDA FEBRUARY ESTIMATES – WORLD SUPPLY & DEMAND 09/10 Updated 04/13/2011

21. USDA APRIL ESTIMATES – WORLD SUPPLY & DEMAND 10/11 Updated 04/13/2011

22. 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.

23. USDA APRIL ESTIMATES – U.S. SUPPLY & DEMAND 10/11 Updated 04/13/2011

24. 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.

25. U.S. Exports Sales & Shipments as of April 7, 2011 Updated 04/14/2011

26. 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.

27. 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.

28. COMPARISON OF ESTIMATES Updated 04/13/2011

29. COMPARISON OF ESTIMATES Updated 04/13/2011

30. 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.

31. CHINESE STRATEGIC STOCKS • CNCRC STOCKS MAY 2009: 4,000 MM MT • SOLD MAY – DEC 2009: 2,642 MM MT • SOLD AUG-OCT 2010: 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

32. 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.

33. 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 F0R COTTON, ESPECIALLY AS INCOMES INCREASE.

34. 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.

35. 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.

36. 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 1990-2009 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 Q1 2012 FOR PRESSURE TO BE OFF OF SUPPLIES AND PRICES.