Ultimate Guide To Cotton Investing

Cotton is a crop that has been around for centuries and has been important to numerous civilizations throughout history. The crop is most often spun and woven into yarn or textiles to be worn as clothing. In fact, historical evidence suggests that cotton clothing has been around since prehistoric times, and it continues to be an important commodity today. Cotton is the main component of many of our shirts, towels, bed sheets, jeans, socks, underwear, etc. The fluffy commodity is also a popular investment for numerous traders. Cotton has the potential to serve as a useful hedge against inflation, and can also be used for profit during strong economic times, or during times of high demand for raw materials. There are a number of different options to invest in cotton, including futures contracts, stocks of companies engaged in cotton production or planting, and ETFs [see also The Guide To The Biggest Companies In Every Major Commodity Sector].

Physical Properties And Uses Of Cotton

Successful growth of this crop requires sunshine, moderate rainfall, and soils typically need to be very heavy. For the most part, these conditions can be found in the dry tropics and subtropics in the Northern and Southern hemispheres.

Aside from its well known use as a textile, cotton can produce cottonseed oil, which can be consumed as though it were any other vegetable oil.  In addition to textiles, cotton is used in fishnets, coffee filters, tents, and gunpowder [see also Invest Like Jim Rogers With These Three Agriculture Stocks].

Cotton Supply And Demand

As the world’s population continues to spike, the demand for cotton will inevitably do the same. More inhabitants of the earth will call for clothing, and other major uses of this crop to increase drastically. This is evidenced by the fact that emerging markets account for the highest cotton consumption in the world, with China, India, Pakistan, Turkey, and Brazil making up the top five consumers on a global scale. As a whole, this bloc of five countries accounts for over 75% of global consumption, proving that emerging markets dominate the cotton market.

World Cotton Consumption
(Millions of 480 lb. bales) 2006/07 2007/08 2008/09 2009/10 2010/11 January 2010/11 February
China 50 51 44 50 47 47
India 18.1 18.6 17.8 19.7 21.5 21.5
Pakistan 12 12 11.3 10.9 10.2 10.2
Turkey 7.3 6.2 5.1 5.8 5.9 5.9
Brazil 4.6 4.6 4.2 4.4 4.5 4.5
Bangladesh 3.2 3.5 3.8 3.8 4 3.9
United States 4.9 4.6 3.6 3.5 3.6 3.6
World Total 123.8 123.3 110.1 118.5 116.6 116.6
Source: USDA

On the production side of the market, emerging markets still have a firm grasp, with the top five producers being China, India, United States, Pakistan, and Brazil. Together, these five nations make up nearly 80% of global production, meaning that cotton prices have heavy ties to a select number of countries from around the world [see also Three Mining Companies With Robust Yields].

World Cotton Production
(Millions of 480 lb. bales) 2006/07 2007/08 2008/09 2009/10 2010/11 January 2010/11 February
China 35.5 37 36.7 32 30 30
India 21.8 24 22.6 23.2 26 26
United States 21.6 19.2 12.8 12.2 18.3 18.3
Pakistan 9.6 8.6 8.7 9.6 8.8 8.8
Brazil 7 7.4 5.5 5.5 8.2 8.2
Greece 1.4 1.6 1.2 0.9 0.9 0.9
Syria 1 1.1 1.1 1 0.8 0.8
Rest of World 7.7 7.3 6.3 5.3 6.1 6.9
World Total 121.8 119.7 107.1 101.5 115.5 115.3
Source: USDA

Cotton Price Drivers

As a global commodity, the price of cotton is impacted by a number of factors, and is often subject to significant price swings in a relatively short period of time. The major price drivers of cotton include:

  • Subsidies: In the United States, cotton is one of the most subsidized crops, as the government offers subsidies that total more than five times those available for grain producers. A change in government spending or subsidies within domestic borders could lead to major price swings
  • Weather: Like numerous other commodities, cotton prices have heavy ties to weather patterns in production regions. Heavy rains or droughts can delay harvests or lead to lower than anticipated results. Because weather patterns, especially extreme ones, are difficult to predict, cotton prices can often surge on news of a potential disruption.
  • Synthetic Fibers: Numerous researchers and companies have worked to develop synthetic fabrics to compete with cotton and the issues this crop faces. Such products include Nylon, Acetate, and Rayon. Any big break or bust in the synthetic fibers field could lead to hefty cotton price swings.
  • Emerging Markets: As noted earlier, emerging markets account for the majority of global production and consumption of cotton. Any trends or major changes in these steadily growing economies could send cotton prices into a frenzy.

Investing In Cotton

Cotton Futures

Cotton futures are traded on the Chicago Mercantile Exchange, with prices quoted in U.S. Dollars per pound. A single contract represents 50,000 pounds of cotton with a minimum fluctuation of $0.0001 per pound. Listed contracts conduct trading in the March, May, July, October, and December cycle for the next 24 months. All contracts are subject to the rules and regulations of NYMEX.

Trading terminates on the day immediately preceding the first notice day of the corresponding trading month of Cotton futures at ICE Futures US.

Cotton Equities

Investors can also gain exposure to the soft commodity via the stocks of companies that are involved in the planting and production of cotton as listed below.

  • Monsanto Company (NYSE: MON)

Cotton ETFs

There is one cotton specific ETN that invests in a single-commodity sub-index which consists of one futures contract on the commodity of cotton. The iPath Dow Jones-UBS Cotton Total Return Sub-IndexSM ETN (BAL) gives investors cotton exposure through an exchange-traded ticker, charging an expense ratio of 0.75%. There is also an ETF which invests in “soft commodities”, which offers 33% exposure to cotton.

  • iPath Dow Jones-UBS Cotton Total Return Sub-IndexSM ETN (BAL)
  • iPath Dow Jones-UBS Softs Total Return Sub-IndexSM ETN (JJS)

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