The Rupp Report: The Cotton Market Goes Crazy

In recent months, the Rupp Report regularly has informed its readers about developments in the
cotton industry. Changing markets and rising domestic needs, mainly in Asian countries, have
culminated virtually in a cotton rally.

During the International Textile Manufacturers Federation (ITMF) conference in São Paulo,
Brazil, in October, cotton was the big issue. Not only its sustainability, but also price
developments were in the center of attention. Experts representing producers, traders and also
federal organizations expressed their concerns about the development of the cotton industry in
general and cotton trade in particular.

Not A Major Crop

According to many sources, cotton plays an important role as leading crop. However, experts
estimate that cotton only has a global share of only 2.3 percent as a seed. Wheat, with a
15.2-percent share; maize, 11.23 percent; rice, 11 percent; as well as fruit and vegetables, 7.6
percent, play much more important roles than cotton.

However, in the past 18 to 24 months, raw material crops such as cotton and others have
raised also growing interest among speculators. According to some information given in São Paulo,
the world cotton market is some 3 million bales short of satisfying the current market demand. On
top of that, in consideration of ongoing export restrictions and the growing demand for cotton,
prices are skyrocketing.

Highest Peak Since 1870

According to the latest information from United Kingdom-based Plexus Cotton Ltd., New York
futures had another price explosion, with December closing at 121.68 cents — a gain of 597 points,
while March rose an incredible 859 points to 118.80 cents.

As Plexus reported on October 28, “Cotton futures reached their highest peak since trading
began on the New York Cotton Exchange in 1870, with the December contract posting an intra-day high
of 130.50 cents and a closing high of 129.59 cents on Tuesday [October  26]. Only during the
Civil War (1861-1865), when a blockade imposed by the North prevented cotton from being shipped to
Europe’s textile mills, were cotton prices higher at 189 cents.

“But the NY futures market wasn’t alone with its record-breaking performance as the A-index
posted an all-time high of 147.00 cents on Wednesday and the Chinese spot futures contract closed
at a mindboggling 204.67 cents today. As we have stated before, it is the physical market, led by
an out-of-control Chinese market, which has been the driving force behind this rally. … [S]ince
July 21, the A-index has now gained an incredible 64.30 cents, while December futures have barely
been able to keep pace, rallying ‘just’ 48.67 cents.

“We still believe that we need to look at the physical market for clues as to where the
futures market might be headed — not vice versa. As of today, mills are still willing to pay
140-142 cents for prompt high grades landed the Far East, while prices for first quarter shipments
were in the 132-136 cents range and Brazilian/Australian high grades for summer 2011 shipments are
currently in the 124-130 US cents range.

“Therefore, if we look at 135 cents for Feb/March shipment, December futures make sense at
121-122 cents. Earlier this week, when the December contract briefly rose to 130 US cents, it was
clearly overvalued in terms of what mills were willing to pay for Feb/March shipment at that time.”

Perhaps sarcastically, Plexus refers to the old saying that “the best cure for high prices is
high prices.” Another factor is — and that was widely confirmed at the ITMF conference in São
Paulo — that the global markets, and therefore the spinners, are looking for better quality and
consequently fine count ring-spun yarns. On the other hand, open-end (OE) spinners are in trouble,
mainly because the raw material cost accounts for a higher portion of the total production cost.
According to Plexus, there are rumors of an OE mill stopping production and selling only its
current yarn stocks at a very high profit.

Too Much Money

Another focus of attention in São Paulo was the weak US dollar as another element to boost
cotton prices. Many experts articulated their concerns, and Plexus also cites the behavior of the
Federal Reserve and its “quantitative easing.” To make a long story short, too much money is on the
markets to buy treasury bonds in order to keep interest rates low. The US gross public debt is said
to be close to $14 trillion and continues to grow by some $2 trillion a year.

As Plexus states: “There is a limit as to how much longer investors and foreign Central Banks
are able and/or willing to keep this game going. … Imagine what will happen to the US dollar if
the Fed had to monetize several trillion dollars of debt over the coming years?” At the end of the
day, the value of the US dollar would be further weakened and that would lead to even higher
nominal commodity prices.

A Look Into The Crystal Ball

According to Plexus: “Based on where physical prices are trading right now the December
contract is more or less fairly valued. Forward pricing currently suggests that physical prices
will gradually weaken as we head into the first and second quarter, but this would only make sense
if demand destruction were to erase the seasonal production gap over the coming months. However,
should demand prove to be more resilient than anticipated, or if the Chinese Reserve came in to
absorb a million tons or two into its stock, then the third quarter might turn into a rather
explosive affair.”

We’ll see.

November 2, 2010