This is the fifth in a series of articles looking at the top 10 most important drivers behind some of the main commodity futures prices. Episode 5 looks at cotton prices.
1) Economic growth
A shaky economy tends to dent consumer spending on discretionary items such as cotton sheets, shirts, and jeans. It may also lead to a substitution effect towards cheaper man made polyester clothing and away from cotton.
2) Government policies
Many cotton producing countries have sought to insulate their farmers and the textile industries upon which they depend from external competition (see driver no. 4), changes in these policies (eg, subsidies) can have a disproportionate impact on other global cotton producers. For example the US government has subsidised US cotton farmers since the 1930’s, to a greater extent that farmers of other crops. However, these subsidies distort global flows of cotton.
3) The weather
Changes in weather patterns resulting in a lack of rainfall, particularly at a certain time in the planting cycle can significantly impact overall cotton production. Cotton requires plenty of sunshine, fertile soil and preferably no frost. Because it needs 24-48 inches of water annually, transplanting cotton from its original subtropic habitat is difficult. As cotton production has progressed around the world, adequate irrigation has become essential in growing robust plants.
4) Chinese stock-building
Between 2011 and 2013 China implemented a cotton stockpiling program, purchasing the fibre if prices fell below a set floor. The program acted as a price support for Chinese cotton farmers, guaranteeing them a minimum price for their cotton harvest. By the end of 2014 the International Cotton Advisory Council estimated that China held 60% of global cotton stockpiles. Just as constructing this stockpile was one factor leading to a surge in cotton prices so any attempt to off load the stockpile is likely to pressure global cotton prices.
5) The price of synthetic fibres
Cotton competes with polyester in the worlds fibre and apparel markets. The post-2009 jump in cotton prices led China to vastly expand its capacity for purified terephthalic acid (PTA), the oil-based raw material for polyester. PTA prices in China have declined sharply since mid-2014 improving the price competitiveness of polyester vs cotton, a further drag on cotton prices. The sharp spike in the price of cotton during 2010 and 2011 forced many clothing manufacturers to switch to cheaper man-made fibres instead. Despite lower cotton prices since then, clothing manufacturers have been reluctant to switch back.
6) Oil prices
Cotton has the largest per-acre energy costs of all agricultural commodities and so so changes in the price of oil can also directly affect the price of cotton. According to a recent report the historical correlation between cotton and crude is the highest across all commodities at 0.45:1. In addition changes in crude oil prices affect the price of polyester, a substitute to cotton in the manufacture of textiles.
7) The US dollar
Like most internationally traded commodities cotton is priced in US dollars. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa.
Cotton prices have a relatively high inverse correlation against the dollar of around -0.47.
8) The price of competing crops
Although cotton competes to some degree with wool and synthetic fibres the land and resources upon which the cotton is grown has to compete with other agricultural crops, such as corn and wheat which may enable the farmer to fetch a higher price and better returns than cotton. Higher prices for other crops may result in farmers planting less cotton, in doing so leading, eventually to higher cotton prices.
9) Main producers
The medal for largest cotton producers is closely fought between China and India. Following a distant third is the US, followed by Pakistan and Brazil. The most up-to-date information on crops comes from the US Dept. of Agriculture. Reports on US sowings and harvests as well as projections for other main producers if watched closely by cotton traders.
10) Seasonal factors
Cotton futures prices tend to peak around March/April, but be at their weakest between August and November.