Prepared by

Prudential Securities, Inc.

Even as the 1996/97 cotton season ended on July 31, the market was unable to spring to life but continued the dull trading range it had exhibited since August 1996. The extreme moves were roughly between 70.00 cents per pound and 78.00, but the bulk of activity was between 71.00 and 76.00. There can be little doubt that supply and demand were in exceptionally good balance.

In spite of these trading range limitations, on July 7 the Cotton Exchange reported its largest volume of contracts ever: 39,433. This surge was caused by a flood of sales by commodity funds which forced the market down by approximately 200 points. Four new lows were made in the first half of July, driving December down to 73.20. The actions of the trade were the most frequent counterbalance, with all other participants playing minor roles. In summary, commodity funds were a major contributor to market moves throughout the entire season.

The crop of 1996/97, estimated at 18.94 million bales in the latest USDA report was based on 707 lbs./acre grown on harvested acreage of 12.87 million acres.

This figure represents the second largest output since 1993, surpassed only by 19.66 million in 1994. Domestic mill use at 10.85 million bales and exports at 7.0 million were among the upper ranges of past years and resulted in ending stocks of 4.1 million after taking imports of 410,000 bales into consideration. In comparison, the 1995/96 carryover was only 2.61 million bales.

The USDA's August assessment of U.S. production prospects for 1997/98 was the result of yield surveys in only five states (Louisiana, Arkansas, Mississippi, Texas and California) and is, therefore, not as complete as it will be in the September report, which will be based on a survey of the entire cotton belt. It must also be taken into consideration that the latest figures are as of August , before the heavy beneficial rains fell over most important production areas early in the month. As a result, we may see increased yields throughout the region. Estimated output was 17.78 million bales versus 18.94 in the previous season. Apparently a larger harvested acreage of 13.41 million (a 4% increase) resulted in a smaller crop due to a lower yield of 637 lbs./acre versus the previous season's 707. Planted acreage of 13.91 million suggests an abandonment of only 3.5%, less than half of the average. Output in the various regions was as follows:

	Area			1997/98		1996/97
1)	Southeast		4.20		4.33
2)	Memphis Territory	4.72		6.06
3)	Texas			5.20		4.35
4)	Far West		3.10		3.25

Domestic use at 11.0 million bales was an increase of 150,000 bales from last season, whereas exports at 7.1 million showed an increase of 100,000. Ending stocks were projected at 3.8 million versus 4.1 last season, and the stocks-to-use ratio declined slightly to 21% from 23% in 1996/97.

Since August, the beginning of the new season, futures have trended generally lower. December 1997 reached a new contract low of 72.40, joined by March 1998 at 73.70, May 1998 at 74.60, and July 1998 at 75.40. Open interest as of September 3 was a record 88,213 contracts. Prior to the end of August the highest figure was 81,942, set on March 17, 1995.

With crops in this country and in the world making good progress, a plentiful supply of cotton seems assured, the only wildcard being the weather, which, particularly in this season, may stray far from the normal because of El Nino's influence on world climates. Furthermore, cotton's seasonal price tendency shows a downtrend into August with a slight uptrend into September and October.

World production of cotton was estimated at 87.34 million bales, an increase of 430,000 bales over July, but 1.15 million bales less than in the previous season. Ending stocks at 35.90 million were increased by 660,000 bales over the July figure but are 1.06 million less than last season's. The major changes in foreign production were those of India and Uzbekistan, which posted increases of 500,000, and 200,000 bales, respectively.

For the first time since December 1, 1994 a so-called step 2 “Marketing Certificate,” representing payment of 57 points (0.57 cents/lb.), was issued on July 10. These marketing payments are activated if:

1. The U.S. North European price exceeds the “A” Index by more than 125 points for four consecutive weeks.

2. The AWP (Adjusted World Price) is within 130% of the base loan rate (presently 67.50 cents).

3. Step 3, which is the “Special Import Quota,” does not trigger in the same week.

The USDA makes payments to eligible domestic users for cotton consumed at the mill and to eligible exporters during a week a Step 2 payment rate is in effect . The payment rate is equal to the difference of the four-week period between the U.S. North

European price and the “A” Index minus 125 points.

Although payments are of definite benefit to domestic mills as they receive funds when they open cotton bales for spinning during the payment period, it is next to impossible for exporters to calculate their “subsidy” because it is based on the rate in effect on the on-board-date of the bill of lading. Since cotton is usually sold for deferred shipment, exporters have no way of making adjustments to their sales prices.

With the end of the season just passed, the National Cotton Council has revised its seasonally adjusted annual cotton usage rate by going back to July 1996. For the 1996/97 season the council now estimates offtake at 10.95 million bales compared to USDA's 10.85. Ending stock figures could not as yet be obtained since the NCC only publishes them after it receives the final 1996/97 U.S. export figure, expected to be released in September.

The latest 1997/98 Export and Sales report covering the week ended 8/21/97 indicated a surprisingly favorable weekly net sales figure of 252,600 bales. China was the largest buyer with 114,300 bales, followed by Japan with 41,900. Sales outstanding were 2.46 million bales and the total sales commitment figure was 2.76 million. These figures include a carryover of 691,700 bales.

China

China's 1996/97 cotton production was 4.2 million metric tons (MMT), down 11.9% from the previous year. Ending stocks, however, rose 16.7% to 868,000 m/t. Continued relatively high levels of imports and sluggish offtake were blamed, yet the country's central government-dictated cotton import plan called for little in the way of changes this year in order to draw down growing stocks. As a result, the “China Cotton and Jute Company,” which is the government's official marketing and warehousing organization, is feeling increasing financial pressure as it has to maintain government dictated prices versus the cheaper imported cotton.

In 1997/98 planted cotton acreage and production in China are expected to decline because of an increase in wheat acreage and relatively low incentives for cotton farmers. Furthermore, relative to other competing crops, returns from cotton are poor. The present idea is for a crop of 3.5 MMT (16.0 million 480-lb. bales).

Although 1996/97 imports at 544,000 tonnes are higher than initially forecast, 1997/98 figures will probably not increase much. Imports are contingent on a number of policy issues facing the central government, but little information is available at this time about any possible changes. There is no doubt that cotton imports should remain at a robust pace as long as domestic prices stay above those of the world.

Chinese government policies, however, must be closely monitored as any changes have the potential to substantially reduce importation. The long-term outlook is for continuing imports and consistent, but small, exports. It will be difficult for cotton production to rise because of high competing crop prices which will limit yield increases. Also, a rising share of synthetic fiber in yarn output will slow the rate of growth of cotton yarn production. Nevertheless, China is expected to be a consistent net cotton importer.

Textiles and apparel account for around 30% of China's total export earnings. This high a percentage makes the industry important enough for the government to maintain more control over cotton than other agricultural commodities. Yet, financial pressure may move the central government to initiate some as-yet-unspecified reforms for cotton.

Such a reform was recently discussed in a meeting of the National Cotton Conference in Beijing when the question of domestic price policy and accumulated stocks was debated. Stocks could be reduced by cutting the domestic price to mills which, of course, would influence import demand. But whether imports would be much reduced is an open question as recent reports still emphasize serious drought conditions and, therefore, a smaller crop for this coming season.

Latin America

Latin America now accounts for 25% of U.S. exports. Their U.S. imports increased from 200,000 bales in 1992 to 1.2 million bales in 1996/97. Latin America's mill use has exceeded its production since 1992 and, for instance, production last year actually decreased 10% while consumption increased 4%. Brazil is their largest importer–the majority of its population under age 20 shows an ever-increasing preference for casual clothing especially if made from cotton. Jeans are very popular there.

Because of attractive prices and better crop financing, cotton production in the southern hemisphere is expected to increase as much as 20% in 1997/98, an impressive change from the situation during the past season. Another very important reason for the shift away from the Far East to Latin America is the Asian monetary turmoil brought on by the devaluation of the Thai baht on July 2. Indonesia, Malaysia, the Philippines, and lately even Hong Kong have all been affected and will only reluctantly shell out more of their currencies to buy dollars to cover their cotton purchases.

Up to the beginning of the 1997/98 crop year, weather conditions over the cotton belt have not been too favorable. Droughts have plagued many areas, especially the Memphis Territory and the Southeast. Planting got a late start, and in spite of very beneficial rains in the beginning of August, the Memphis Territory and the Southeastern crops are still about two weeks late. Furthermore, weather services have predicted an early fall which could raise havoc with late-planted cotton.

Production

The strong El Nino weather pattern that has developed in the tropical Pacific is likely to result in drought conditions in Queensland (Australia) and in China, as well as many other parts of the world. It is in these two areas, however, where cotton production could be affected. Queensland produces about 23% of Australia's cotton crop, which is estimated at 2.86 million bales for 1997/98. El Nino's effect cannot be disregarded even in the U.S. cotton areas. In the past, it has caused higher rainfall and warmer-than-normal temperatures in the West and across the Southern two-thirds of the country.

In view of these problems, it is extremely difficult to predict cotton's futures price development. Whereas trading ranges were previously expected to continue within the narrow limits of the past season, it is now quite possible that futures may trade in much wider price ranges and even extremes. Without considering the effects of inclement weather, a large crop could depress prices to the 70.00-cent level and even the high 60's, which we would consider a good buying opportunity. December futures would be our preference.

September 5, 1997Ernest Simon

Prudential Securities, Inc.

1 New York Plaza, New York, New York

Consensus National Futures and Financial On Line Index

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