COMMODITY REVIEW - COTTON

                                                                                         

Intended Audience:

Personal investors looking to speculate on the price of cotton through trading of future contracts. As well investors examining companies that have their operations impacted by the movements in the price of cotton (ex. Critical input factor, etc).

Summary Points to Take Away

•Drop in acreage dedicated to cotton resulting in lower supply; thus, placing upwards pressure on the price of cotton.

•Competition from Synthetics, which acts as a substitute for cotton within textile manufacturing, leading to lower demand for cotton; thus, placing downward pressure on the price.

•Cotton requires a lot of water to grow – which is a significant future issue given that water is likely to be a scarce resource in the future. Manufacturers will look for alternatives; thus, reducing demand the putting downward pressure on the price.

•Textiles are a cyclical good; thus, due to current state of global economy – lower demand for textile products; thus, resulting in less cotton being required by manufacturers.


Factors leading to Increase in price of Cotton

Drop in Acreage dedicated to Cotton

Acreage rotation refers to the amount of acres farmers are allocating to certain types of crops for the upcoming fiscal year. The rotation part reflects the fact that some farmers change crops annually to those that they expect will yield the most cash flow. Three biggest producers are China, India and US – specifically in China and the US, corn has been increasing in acreage given the rise in demand for ethanol fuel; thus, taking away acreage from other goods – such as cotton. As well in China, for fiscal year 2009 – the local government is taking action to increase the acreage allotment to food as there are worries of shortages; thus, non-food grown items such as cotton are likely to have less farmers dedicated to producing it, resulting in a lower supply; hence, higher price.

Factors leading to Decrease in price of Cotton

Competition from Synthetics
Number one substitute of cotton within the textile industry is synthetic material. A drop in the price of synthetic material would result in lower demand for cotton; thus, a lower price. Two factors are expected to put downward pressure on the cost of synthetic material:

(1)Fall in oil prices, which is the most significant input into the production of synthetic material. Average price for fiscal year 2008 was close to $100 a barrel – currently trading at around $40 a barrel.

(2)Future technological advances in the manufacturing and process of synthetic material is bringing down fixed and variable costs annually – which poses a dark cloud for the future demand of cotton.

Thirsty Crop

Cotton is a thirsty crop (as compared to others), and as water resources get tighter around the world, economies that rely on cotton production face difficulties and conflict, specifically Africa – which is the second biggest exporter of cotton globally ($2.1 billion out of a total $12 billion market), since water is scarce. From a long run perspective – water resources will continue to be strained (given exponential increases in population, etc.); thus, textile manufacturers will use substitutes; thus, bypassing the need for cotton.

Impact from current North American Recession

Demand for textile products (i.e. clothing, etc) are positively correlated with higher consumer incomes. Given the current state of the global economy – incomes are remaining static or declining due to worldwide layoffs. Lower short term demand for textile products is expected; thus, manufactures will demand lower levels of cotton; thus, leading to a depressed cotton price.

Where to go from here?

Cotton is publicly traded on the NYMEX futures exchange for those investors wishing to speculate. Above analysis will also impact the analysis of those researching various companies that use cotton as a major input, etc.

About the author:
Simon Giannakis is the founder and creator of WWW.THATSTOCKGUY.NET. He currently is a Senior Accountant within the Assurance and Advisory group at Deloitte & Touche LLP in Toronto, Ontario. He has a BBA degree from Wilfrid Laurier University and is currently pursuing both CA and CFA designations. Simon can be contacted through thatstockguy.net@gmail.com

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