Cotton futures fall precipitously

03 May '08

3 min read

There is a lot of talk these days that the commodity bubble has burst and that prices are headed for a considerable decline in the months ahead. While the commodity complex as a whole may undergo a severe correction, there will be widely differing performances among the various commodities and we need to be careful not to throw the baby out with the bathwater.

The dynamics for other commodity are different because of its increased use for ethanol, which constantly adds demand that may actually outstrip production.

So where does cotton fit in? First of all, even though the price of cotton is higher than it was in the previous 4 years, it is by no means expensive by historical standards. When we look at a 30-year chart, we notice that spot cotton is just about at its long-term average price.

In other words, cotton has never taken off like its competitors in the grain markets and it should therefore not get punished as hard if some of these high-flyers correct.

When we look at the drivers behind today's commodity prices, we still have to a large degree the traditional supply/demand factors, but in recent years there has been a noticeable increase in spec participation, particularly from index funds. These securitized investment products have driven up open interest much beyond historical norms and have put a permanent bid under the market.

These long-only, fully collateralized positions need to be viewed as longer term investments which depend entirely on money flows from their investors, such as pension funds, insurance funds and retail clients. Until now we have seen these investments grow and there is no reason to believe that this is changing anytime soon, quite to the contrary.

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Plexus Cotton Limited

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