Cotton simply playing catch up with other commodities

04 Dec '10

6 min read

When we measure the price of cotton in a currency that is being debased, like the US dollar or the Euro, we are seeing a strong rise in nominal terms. However, when we replace the US dollar with gold, silver, copper, crude oil or even soybeans, wheat and corn, we get an entirely different outcome. When we plot a chart of the cotton price measured in ounces of gold, silver, barrels of crude oil or bushels of grain, we will find that cotton has simply been playing catch up with other commodities.

For example, since the credit bubble went into overdrive about 5 or 6 years ago, cotton has more or less doubled from what used to be a 60-70 cents base. During the same time frame silver has gone up four-fold, gold three-fold, copper and crude oil more than two-fold, while corn, soybeans and wheat have also about doubled in price.

Are commodities going up in value or are we simply witnessing an erosion of the purchasing power of fiat currencies? We are not just talking about the US dollar, but any currency that is based on nothing more than promises. That's why it is immaterial whether the US dollar is sinking a bit faster than the Euro at any given moment or vice versa.

The US may have the biggest pile of 'empty promises', but the situation is hardly any better in Europe and many of the Asian economies. In the broader context it may simply boil down to comparing tangible goods (commodities) to an ever-increasing amount of empty promises (currencies). As investors are starting to catch on to what is happening to their traditional store of value, they are increasingly looking to diversify into value-preserving assets, such as commodities.

And here is the scary part! There are currently about 90 trillion dollars in the global bond market and about 40 trillion in global equities, while commodity index funds hold just about 0.34 trillion dollars and hedge funds may own another 0.2-0.3 trillion in commodity investments. Imagine what would happen if even a small percentage of these bond and equity holdings decided to switch to commodities!

So where do we go from here? A persistently strong physical market has forced a turnaround in the futures market. With only about 10-15% of the US crop remaining available; it is unlikely that there will be any pressure on physical prices for the remainder of the season. Quite the contrary seems to be the case! Importers are scrambling to lock up remaining supplies before they run out altogether, which is underpinning prices.

Under such a scenario the futures market will continue to follow the lead of the cash market. We have no idea how high cash and futures prices may eventually go, but the thinner the market gets, the more dangerous and volatile it will become. We have never had a season in which nearly the entire crop was committed this early on and it will be interesting to see how the upcoming delivery periods of March, May, July and also October are goingto deal with this situation. Don't be short unless you have the cotton to back up your bet!

Plexus Cotton Limited

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