February 21, 2007
You decide for yourself...
Unless a commodity is becoming obsolete, world demand (or consumption) for that commodity tends to increase over time simply as a function of world economic expansion and population growth. Cotton is not becoming obsolete and the World Cotton Consumption chart below reflects exactly what you might expect; the rise in demand for cotton has been creeping steadily higher for the past 40 years...with an especially noticeable increase during the past 3 years,
During those same 40 years, world cotton production has had to increase as well (otherwise prices go to the moon) and the next chart shows this to have been the case. Production, however, does tend to be more erratic than demand, with periodic dramatic shifts both up and down...Weather can obviously be a factor, but those fairly sharp changes in production are often in response to either high or low prices. High prices encourage lots of acreage...Low prices do the opposite as farmers choose to cut acreage or plant other crops which offer them better prices.
1984, 1991, 2001 and 2004 are noted as years when world production jumped sharply into new record highs. As a result of excess production, prices then went lower in all four cases...Those low prices then led to production decreases as farmers cut back acreage or switched to other crops. Meanwhile, in all four cases, world demand remained typically firm...The end result can be clearly seen on the following chart: Following each of those first three record production highs cited above, note that within one to two growing seasons, demand had overwhelmed supply and Cotton began respective rallies of 50, 30 (eventually 60) and 55 cents...With the most recent case (the 2004 production high) having yet to be fully played out.
I CAN ASSURE YOU THAT EVERY SINGLE ONE THOSE UPTURNS SHOWN HERE WERE ACCOMPANIED BY MASSIVE COTTON STOCKS ON HAND WHEN THIS MARKET WAS DEAD ON ITS LOWS. I CAN ALSO ASSURE YOU THAT EXPORTS WERE "LOUSY" AND THE IDEA COTTON COULD RALLY 30-40 CENTS WAS CONSIDERED INSANE.
We are now beginning the third year since setting the 2004 record high in world cotton production. Wheat is at historical highs. Ditto Corn, which has now become something of a mania. In the coming year, I have little doubt substantial cotton acreage is going to be "lost" to these and other highly priced crops. At the same time, I see no reason for demand to do anything but continue on its firm upward path...Then throw in the potential for unfavorable weather and I think you have all the ingredients for a classic bull market in cotton...and in today's environment where markets are driven by billions of dollars in fund money, I think it quite possible it could end up being the biggest cotton bull market ever.
My recommendation is to own slightly out of the money calls in both the July 2007 ("old crop" cotton already harvested) and the December 2007 ("new crop" yet to be planted this year) contracts. I have no idea how high this market could go, but would at least expect a 20-25 cent move over the course of the next 12-15 months.
For what it's worth, here's a chart of that corn market...If you were farming, would you rather plant $4.25 corn (only higher once in history), or 55 cent cotton (which has only spent about 10% of the last 30 years at prices lower than they currently are)?
The answer is, farmers worldwide will be switching acreage on a potentially massive scale, and as a result, here's what I think those World Supply and Demand charts will look like somewhere not too far down the road...
If Production is roughly 100 million bales...and Consumption is 120 million bales, I would expect cotton to be trading at least in the 80's, if not a LOT higher than that...
What do you think?
This is it.