Wednesday, April 6, 2011

Cotton - Apr 6th

April 6th, 2011

Extreme Volatility

Cotton has been making headlines for months, setting successive new highs over and over again.  So far this year the fiber has risen almost 45%, and over the past 12 months it is up almost 170%.  Even more impressive (or troubling, depending on your point of view), is the volatility in the futures market.  Over the past 2 months, cotton has closed either locked limit-up or limit-down 19 times, that is a shocking 44% of the time. 

*For those not familiar with the futures markets, the exchanges sometimes set limits as to how much the price is allowed to change on any given day, in the case of cotton the limit is $0.07 per pound.  Considering that the average price over the past decade was around $0.60 per pound, historically that would have been a huge move, now it is simply the norm.*

Front-month Cotton (ICE)
Courtesy of Bloomberg

Very Tight Fundamentals

Unlike many other hyperbolic rallies, the rise in cotton prices has not been driven by excessive speculation, but in fact very compelling fundamentals.  The United States has long been the world’s top exporter, a title ceded to India in 2009/2010, but which it is likely to reclaim this coming season.  Export demand, driven largely by China, has absorbed almost all of the U.S.’s production from last season, leaving supplies at extremely low levels. 

U.S. Cotton Exports & Exports as % of Production
Courtesy of Bloomberg

As you can see, recent exports represented almost all the last season’s production, forcing domestic users of cotton to consume stockpiles.  As a result the carryover is very low (see chart).

U.S. Ending Stocks – Cotton
Courtesy of Bloomberg

The high price has encouraged farmers to plant more cotton this year, with the USDA estimate currently pegged at 12.6 million acres.  This is up from last year, though below what most traders were expecting.  This has been supportive of new crop futures (December contract), which in early March were trading at an $0.89 discount to the cash market, and is now only $0.66 below the spot price.

Seeding has now begun, and is slightly ahead of last year’s pace with 6% planted.  However, Texas is the largest cotton producer, accounting for about half of all U.S. production.  It is also experiencing a very serious drought.  Though this is not a huge concern for the cotton crop at this time, but if the situation persists for another month it could damage the crop and bring further tightness to the market.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group


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