HardAssetsInvestor

Written by Julian Murdoch  |

September 20, 2010

What's Behind Cotton's Rise?

Details

Tight inventories and below-average yields have pushed cotton up 34 percent this year. Will the good times last?

Cotton is one of those commodities that's easy to overlook, despite the fact that most of us live in the fabric. But with low U.S. inventories and rising prices, the commodity's now starting to turn some heads. Cotton closed at 98.22 cents a pound on Friday—that's up 34 percent from July's recent bottom of 73 cents a pound. How much higher can it go?

Tight Inventories + Panic Buying = Short-Term Bump

The top three producers of cotton are China, India and the U.S; these countries produce two-thirds of the world's cotton. Of the three, the U.S. is the largest exporter (which is a bit of a rarity in the commodities universe).

The USDA's current cotton supply/demand estimates predict 2010/2011 production will be up, compared with the two previous years. That might seem to suggest a supply glut, which would be bearish for prices. But comparatively, the past two years were low-production years for cotton.

In addition, estimates put market off-take (or domestic mill use and exports) to be up as well. In fact, the USDA expects consumption to outpace production so much that ending stocks are expected to drop to 2.7 million bales, the lowest number in the past 14 years.

What's more, exports appear more robust than usual this year. Of the 15.5 million bales estimated to be exported from the U.S., 7.3 million bales have already been contracted—just one month into the market year.

Globally, the picture looks similar. Although 2010/2011 consumption, at 120.5 million bales, was lower than last year's, it's still expected to outpace production (estimated at 116.95 million bales). That could result in global ending stocks dropping to 45.4 million bales. To put that in perspective, 45.4 million bales equals 38 percent of current annual demand.

So naturally, these predictions have made textile producers a little edgy. Roger Varner, president of Varner Bros. in Cleveland, Miss., told Bloomberg last week, "The higher the price goes, the more afraid the mills get and the more buying that they're doing. Nobody has any excess. Nobody has inventories. Everybody's waiting for the new crop to get some supplies and be able to continue to operate."

That fear has carried over to the futures market:

As you can see, today's cotton is a lot more expensive than traders thought it would be a year ago. But whereas 2009 cotton buyers saw a slow and steady increase in demand, today we see steep backwardation. That's a sign that the markets believe current prices are an anomaly, which will correct itself by this time next year, as suggested by the implied year-forward price of 87 cents.