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February 21, 2007
Economics 101
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,
Demand
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.
Supply
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?
Thanks,
Bill
This is it.
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