Cotton belongs in the group of commodities regarded as ‘Softs.’ It is a soft, fluffy staple fiber that grows in a boll around the seeds of the cotton plant. Cotton has a very rich history, one of which is the fact that it was grown extensively in India for six thousand years. And today is a part of just about every human being in the world. Its huge importance to humanity has made it become a financial instrument from which investors can profit or hedge their businesses. Here, we’ll be looking into the most important factors that move the price of cotton.
As said earlier, cotton is an important global commodity, which is needed every now and then. Therefore, inventory levels are important. As with any commodity with its price dependent on inventory levels, rising inventories usually lead to lower cotton prices, as it signals that there is sufficient cotton to satisfy the demands. The effect here may be even more intense if a weak demand – or its outlook – accompanies the rising inventories. This is in reaction to fears over a potential glut in the cotton market.
On the other hand, decreasing inventories usually lead to a price hike. What happens is that decreasing inventories causes traders to fear that the available cotton inventories will not satisfy demands. As in the case of rising inventories, if a rise in demand accompanies the decreasing inventories, the surge in cotton prices might be greater.
Here is a real life instance for reference. August 19, 2014, Financial Times reported that the cotton market has unraveled as prices decline in the face of record global stocks. Since June 1, 2014 up until the time the story was published, ICE cotton futures had declined by 26.6 percent.
In addition, it said that cotton has fallen in 2014 more than any other agricultural component of the S&P GSCI commodity index – at the time of reporting. For the most part, the decline is in response to expectations of a record harvest in the US, prompting, prompting traders to fear a glutted cotton market, following uncertainties over cotton policies in China.
While the rise here was driven by US production outlook, a similar trend would be noticed if any other top cotton-producing/exporting countries – Uzbekistan, for instance – were involved.
Chinese production and consumption outlook
In simple terms, Chinese production and consumption outlook matter to the cotton market because China is both the largest producer and consumer of cotton. As the world’s largest producer, if China’s cotton production drops, says because of unfavorable weather conditions, you can expect that a surge in cotton prices will follow. This signals two things. First, there is going to be potential drop in global stocks. Second, it signals that China might need to import more cotton than usual. Both of these points belong on the list of things that send prices higher. By the way, the reverse of the case above (an increase production) is likely to send prices low, as it signals that global stocks will rise and that China is likely to import lesser cotton than usual.
Here’s for the consumption side of the equation. China has been the biggest importer of cotton since 2008, and there are no signals of a decrease in demand on the horizon. However, in general, when the demand outlook in China is weak, chances are cotton prices will decline. On the other hand, a positive demand outlook is likely to send prices higher.
For instance, as stated earlier, the 2014 decline in cotton prices is partly due to the weak demand outlook in China. This goes to show that investors should always monitor demand trends in China when looking to predict cotton prices.
US export data
This has been touched on earlier. To be clear, the US is so important to the cotton market because it is currently the biggest exporter of cotton. So in general, a positive export data in the US would usually send cotton prices higher, while a weak US cotton export data is likely to send cotton prices lower. It’s easy to confuse this with global stocks because they are related to certain extent. However, it is a different factor. It is more of an indication of global cotton demand than global stocks. And, for the record, if at any time, the US seizes to be the leading cotton-exporting nation, you just need to replace US with the new top exporter.
Like most agricultural commodities, weather conditions are a big mover of the cotton market. Simply put, rainfall is important for cotton cultivation. This tells us that if there is drought – or its outlook – in top cotton producing nations, cotton prices are likely to go up, as it put pressure on supplies. On the other hand, abundance of rainfall will send prices low, signaling that increased production is imminent. For instance, according to analysts, the price decline in cotton prices in 2014 is partly due to abundant rainfall in the US – Texas to be specific, the top US cotton-producing state. This led analysts to predict a 10 percent increase in US cotton output for the 2014-2015 season.
In general, if any other top-cotton producing country like China were involved, you can expect to see a similar trend. This is to say that investors should monitor climatic trends in top-cotton producing countries as well.
History has thought us that emerging markets should be seriously considered in the cotton market. As long as they are still developing, at every point in time, demand for cotton is at a low level by default. Therefore, it means that the more they develop, the more likely it is that the demand for cotton will rise. China is a prime example of what we are talking about here. In 2000, China was regarded as a net exporter of cotton. However, by 2008, the country had become the largest net importer of cotton. That incredible turnaround is mostly due to the fact the Chinese economy grew significantly over that period. The point here is that such surge in demand should be expected in countries that that are experiencing significant economic growth. They may not become the largest net importer, but they will sure increase global cotton demand.