The fabric of our lives

In 2010-2011 the price of Cotton surged from 0.70 USD / lb to over 2.20 USD / lb.  At the time the run up in prices was attributed to flooding in Pakistan (world 4th largest producer), poor harvest in China (the worlds largest cotton producer and consumer), supply problems in Greece and Brazil, and India restricting exports to protect their domestic textile mills (see here here here).

When the ICE #2 Cotton contract for March 2011 expired a squeeze ensued.  When a future contract expires the party with the short futures position is obligated to deliver the physical product in return for the final settle price for the futures, and the party with a long futures contract is obligated to pay the final settle price for the futures in return for the physical product.  Each cotton contract is for 50,000 lbs of #2 grade cotton.  As the supply outlook got worse and worse during February 2011 the shorts (who had less supply than they originally expected) had to get out of their contracts by getting a long position.  This bid up the price of the futures and a squeeze was on.

In the spring of 2011 US farmers moved more farmland into cotton production (see here) and prices subsequently fell.  Its not clear that that was the whole cause of the drop though. 

Last week the US cotton industry asked the federal government for help.  The issue revolves around both the supply side (farmers) and the demand side (textile mills) defaulting on contracts - which has led to a breakdown in the forward market for cotton.  When the price of cotton ran up in 2010 farmers who had made previously agreed to supply cotton for around 0.70 USD / lb reneged on their contracts so they could instead deliver into the spot market for 2.20 USD / lb.   Now with prices having collapsed back to near 0.85 USD / lb textile mills in Asia are reneging on contracts that they agreed to during the price spike - and instead are going to the spot market for supply.  Foreign countries appear to be siding with the mills and now the US suppliers are asking the US government to pressure them to enforce contracts.

Also last week the CFTC handed out some of the largest fines for position limit violations that I can recall.  Surprise surprise ...for speculation in cotton during 2010-2011.  Last week the CFTC fined Sheenson Investments Ltd 1.500MM USD, JPMorgan Chase Bank 0.500MM USD, and ANZ Banking Group Ltd 0.350MM USD all for violating cotton position limits in 2010-2011.

How much of the price run-up was due to speculation and how much was due to farm supply versus mill demand?  It does appear that world stocks of cotton were lower at the end of 2010 than they had been since 2003.  And in the 2009-2010 marketing years mill usage was higher than production (which is why stocks fell).  But it also does not appear that stocks were unusually low.  Maybe it was a scare and maybe speculators.  Cotton..The fabric of our lives