By  on July 1, 2011

There could be little easing up in cotton prices.

Although the U.S. Department of Agriculture said Thursday that the nation’s farmers had boosted the space devoted to cotton by 25 percent this year, to 13.7 million acres, extreme drought in parts of the South and Southeast has left 41 percent of this year’s crop rated “very poor to poor.”

That’s the highest percentage the “very poor to poor” category has seen since the USDA began keeping estimates in the mid-Eighties. This week, the USDA declared 213 counties in Texas, which accounts for more than half of the acreage devoted to cotton, natural disaster areas. That state is in the midst of one of the worst droughts it’s seen in over a century.

The U.S. is the world’s third-largest cotton producer behind China and India, and high cotton prices have given farmers an incentive to devote more land to the crop, said Jon Devine, economist at Cotton Incorporated. But he noted the dry weather could eat away at this year’s projected surplus of 4.8 million bales. That surplus might sound big, but it’s small compared to the shortfall of 17 million bales during the 2009-10 cotton season that forced prices up.

“We’re putting money back into the bank, but we made a huge withdrawal a couple years ago,” Devine said.

Cotton prices have declined slightly lately but, at $1.49 a pound, they are still about twice what they were a year ago and remain important for retail stocks.

Randal Konik, Jefferies & Co. retail analyst, said in a research note that the increase in cotton acreage could be a positive for retailers, but was cautious given the questionable yield.

“We continue to recommend that investors remain very selective with the specialty retail group given sourcing cost uncertainty, potential margin pressures, more difficult [comparisons], less favorable valuations and a lack of near-term catalysts,” Konik said. “We prefer the global growth retailers.”

Concerns about rising production costs and how much price resistance fashion brands will face as they pass along those costs have dominated the retail sector this year. Specialty stores are seen as most vulnerable. Discount players can use their size to subsidize low prices on items such as T-shirts and department stores plan to lean on their broad assortments.

Nobody’s quite sure what will happen this fall when the majority of price increases work their way to the consumer. Kohl’s Corp. and others have said that early tests of higher prices led to lower unit sales, but an increase in overall revenues.

The price question has weighed on retail throughout 2011. The sector hit an all-time high in May even as retailers lagged the market overall. On Thursday, the final day of the calendar first half, the S&P Retail Index rose 0.6 percent, or 2.88 points, to 529.96 as the Dow Jones Industrial Average rose 1.3 percent, or 152.92 points, to 12,414.34.

So far this year retail stocks have gained 4.4 percent, while the Dow Jones Industrial Average has risen 7.2 percent.

The first-half gain in retail stocks.

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