Last week's acquisition by Koch Industries of
Invista fibers unit served as a reminder that whatever the state of the economy or the markets, industries such as textiles and carpets will remain. Clothing may not be an actual necessity -- the precise need is to keep our internal body temperature above 92 degrees -- but it seems to be such a widely accepted social courtesy as to constitute a necessity.
And let us not forget the key role that textiles played, for better and worse, both in European colonial expansion and in the industrial revolution. Cotton played a critical role not only in American history but also in the histories of Egypt, India (remember Gandhi's spinning wheel) and Australia. In the former Soviet Union, it was known as white gold and prompted the diversion of two rivers for irrigation purposes and the subsequent desiccation of the inland Aral Sea.
Eli Whitney's cotton gin created the economic incentive for the westward expansion of both cotton planting and slavery. The English textile industries with their new steam-driven looms made Great Britain the leading commercial power of the 19th century. Even today, textiles remain among the most contentious of global trade and development aid issues.
Industrial and Agricultural
For all of the benefits created by synthetic fibers -- one of Invista's leading products is spandex, which I mercifully do not wear to the gym -- the ancient standbys of cotton and wool still play a critical role. Chances are a good portion of your wardrobe contains these fibers. Both markets share a somewhat unique status, along with commodities such as rubber and jute, of being industrial commodities subject to the cycles and vagaries of agricultural production.
Even with agricultural production constraints, the long-term price trends of both fibers exhibit the classic commodity pattern of a decline punctuated by short-lived price spikes. By the turn of the century, wool prices deflated by the apparel and textile producer price index were at their lowest level on record.
No. 64 Wool Tops Prices in Boston
Wool is a difficult futures market for American traders; the Sydney Futures Exchange offers contracts on "greasy wool" and on two grades of merino wool, fine and broad. Commodities are not pretty: Almost half the weight of greasy wool, which is the unwashed shearing, is lanolin, dirt and trapped vegetable matter. All three contracts are thinly traded and denominated in Australian dollars.
The chart for similarly deflated cotton futures shows a similar pattern, including an all-time low for real prices in late 2001. The production economics for cotton are more complex than those for wool; much of the world's cotton is grown on irrigated land and therefore is subject to the price of the fuels used to power the pumps. In addition, the U.S. Department of Agriculture allocates cotton acreage in this country, export prices are subsidized, and many farmers can switch between cotton and soybeans. The big price jumps in cotton in the 1970s were partly the result of planting decisions in favor of soybeans.
Front Month Cotton Futures
The Chinese Connection
As is the case for so many industrial commodities, the marginal demand for cotton is centered in China. The Department of Agriculture is forecasting 2004 exports of 7 million 500-lb. bales of cotton to China. To put that in perspective of the futures market for cotton, each contract is for 50,000 pounds, or 100 bales. The entire open interest on the New York Board of Trade's Cotton Exchange is 88,701 contracts, so the exports to China will account for 78.9% of present open interest.
The higher prices seen for soybeans in the U.S. this year, also an artifact of Chinese demand, should lead to higher soybean acreage at the expense of cotton in 2004, barring an exceptional South American soybean crop. If Chinese cotton demand grows along with the economy -- and granted the economic development experience elsewhere, this is almost a given -- will a combination of supply and demand factors propel cotton futures back toward the current dollar highs seen in early 1995?
Threading a Needle
Not necessarily: Cotton, like so many commodities, exhibits what is called a mean-reverting price pattern. Prices jump higher out of a range, or drop lower out of a range, but they somehow manage to find themselves returning toward the midpoint of that range, in this case about 68 cents a pound for cotton. And unlike equity prices, whose mean exhibits a strong upward trend over time reflective of the economy's growth, the mean for most commodity prices stays flat. The DuPonts and now the Koches of the world can develop new synthetic fibers and improve their efficiencies of production, but how are you going to get a merino sheep to increase its wool output?
The key to trading cotton is to sell (buy) too soon. Just when this market appears to be a one-way affair on both a technical and a fundamental basis, it stops and reverses and has done so for years. The recent behavior of the front-month March 2004 contract, with its outside reversal and gap lower following a contract high, is typical of what you should expect from trading this market.
March 2004 Cotton
Howard L. Simons is a special academic adviser at Nasdaq Liffe Markets, a trading consultant and the author of
The Dynamic Option Selection System. At time of publication, Simons had no holdings related to this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. The views expressed in this article are those of Howard Simons and not necessarily those of NQLX. As a matter of policy, NQLX disclaims the private publication of materials by its employees. While Simons cannot provide investment advice or recommendations, he invites you to send your feedback to
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