Intercontinental Exchange: Cotton Is King Again


Consistency has never been a hallmark of investors.  The course of a week, a month, or a year will create a roller-coaster ride for a portfolio, leaving some rich and some wondering what could have been.  Commodities enjoy no less volatility than stocks, though not all commodities go through and up and down run that leaves their owners with heart palpitations.  Cotton represents one such commodity that has barely moved in the past 52 weeks as both supply and demand has remained remarkably static through 2015.  All that is set to change by the end of the year, however, when the Intercontinental Exchange (ICE) launches the first foreign cotton contracts in the institution's history.  The new venue for demand will make cotton into one of the hotter commodities in 2016.

What's In A Name

Intercontinental Exchange launched in 2000 with the explicit aim of trading energy commodities.  The Atlanta-based clearing house, backed by some of the biggest names in banking like Goldman Sachs and Morgan Stanley, quickly grew beyond the scope of oil and gas trading to become an all-inclusive trader.  Soft commodities as well as equities and foreign exchange now make up a significant portion of their holdings, although ICE has yet to foray into the territory of base and precious metals (in the current market, it's hard to blame them).  Their soft commodity exchange has become one of the largest in all of North America, second only to the New York Mercantile Exchange.  What's more, they emerged from the recession in much better shape than many contemporaries due to ten trillion dollars -- trillion, with a T -- in credit default swaps.  The waves made by ICE, as such, have grown larger and larger with each year.

Cotton Growing?

Up until the Civil War, American cotton traded on Memphis' Front Street, the agricultural equivalent to New York's Wall Street, back when the southern states produced more cotton than the rest of the world combined.  With the implementation of a Union blockade and the growth of cotton in nations like Egypt and India, however, Front Street quickly became a relic of history as the American cotton market became secondary to international growers.  The doors (famously lined with cotton lint from generations of trading) closed for good, becoming a museum that pays homage to the industry that fed into the greatest war of our nation's history.  Today, American cotton lags well behind India and China and within arm's length of Pakistan and Brazil, nations with far more extensive agricultural economies and available government credit for farmers.  ICE's decision to allow foreign cotton contract trades signals another step in the changing cotton market.  It may seem poor news for American cotton farmers or garment producers, but it's the best thing that cotton investors could hope for.

Clothing Wars

The shift in cotton reflects a shift in global clothing production.  Garment manufacturing represents major factor behind the Trans-Pacific Partnership, should it ever go through all 13 nations' governments for approval.  Nations like Bangladesh and Vietnam produce most of the clothing on our backs today for a fraction of the price of domestic production (go to a clothing store and note that t-shirts "made in the USA" cost $30 each).  Yet these foreign nations play by the cotton rules established by American futures markets despite the fact that the US has become a tertiary player.  ICE contracts for foreign trades of cotton produced in nations like Malaysia have the potential to create the benchmark for cotton clothing like shirts, socks, underwear, jeans, or slacks.  Given that the majority of garment companies (including but not limited to Nike, Ralph Lauren, Old Navy, and Gap) no longer have any domestic manufacturing as well as an increasingly global customer base, the ICE decision comes not just as a breath of fresh air but as a long-overdue change to the status quo.  Raymond Faus, the head of Omnicotton, gave an interview with Reuters stating that everything about the cotton industry has changed with the sole exception of the futures market, which badly needs to catch up.  Given that most of the cotton-producing regions of the Mississippi Delta have switched over to profitable soybeans, investors have the option to lap the field now that ICE has cleared the hurdles.

Changes To The Norm

How will most Americans react to a shifting clothing industry?  Most likely won't notice a difference with the exception of some cheaper socks.  The largest change to clothing prices in the past two decades, the 2001 Texas droughts, would today prove irrelevant since Texas accounts for less than 50% of domestic cotton produced today, having dropped by double-digit percentages.  Investors, on the other hand, have a lot to be hopeful about.  Cotton trades at six-year lows, but overseas demand for cotton has steadily risen since the implementation of the TPP and the tremendous drop of global wool production as farmers in New Zealand and Australia switch to profitable cattle.  The ICE decision gives a valuable boost to cotton by connecting buyers and sellers on a far larger scale than Front Street could have ever hoped for.

  • The Takeaway: there's better value in cotton than in a number of other agricultural commodities.  As the shift in markets makes US cotton less and less relevant to both investors and manufacturers, a welcome change for traders gives a big boost to the cotton game.  Investors should consider cotton as a long-term option: the next twelve months will prove quite valuable as the TPP gets up and off the ground, with the likelihood of continued growth through the end of the decade. 
  • The El Nino weather phenomenon will leave Asia slightly drier while North America gets slightly wetter in the near future.  While cotton isn't as thirsty a crop as some other soft commodities, most notably chocolate, it doesn't tolerate drought particularly well.  Both environmental and market factors appear poised to make it a good buy for 2016.

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