Mumbai: World cotton prices have continued to exhibit a rising trend in recent months.
The market is currently ruling significantly higher than price forecasts made by several analysts and trade experts. That the price behaviour beat expert forecasts seems to have surprised a lot of people including market participants.
While primary producers and exporters have reason to be happy with rising cotton prices, consumers are not.
India is no exception. Despite large production (over 30 million bales in 2007-08 representing 10 per cent increase over the previous year), cotton prices in India too have remained firm, well supported by strong exports.
What has led to the price spurt in recent weeks?
Rise in long positions
A research paper titled “Speculation and Cotton prices” prepared by Alejandro Plastina, Economist with the Washington-based International Cotton Advisory Committee (ICAC) has, based on analysis of data, showed that speculators have played an important role in pushing prices higher.
According to the research, speculators have accounted for increased share of cotton long positions.
Long are those who buy today with expectation of a price rise at a future date. They would sell and book profit when the price objective is achieved.
Pointing out that Open Interest in cotton futures and options contracts more than doubled between January 2006 and February 2008, the author goes on to state that the share of total long positions in the ICE (New York Board of Trade) cotton futures and options market held by hedgers declined from an average of 31 per cent in 2006 to 27 per cent in 2007 and further down to 26 per cent in 2008.
The counterpart of the decline in the share of total long positions held by hedgers was the increase in the share of total long positions held by speculators (individuals and index traders) from 69 per cent in 2006 to 73 per cent in 2007, and then on to 74 per cent in 2008.
Analysing the composition of speculators long position, the research found, individual traders, rather than index traders, accounted for an increasing share of long positions held by speculators, from 50 per cent in 2006 to 61 per cent in 2007 and then on to 65 per cent in 2008.
On the other hand, the share of index traders (pension funds, managed funds, and other traders with predominantly long futures positions replicating commodity indices) declined from 50 per cent in 2006 to 39 per cent in 2007, and then on to 35 per cent in 2008.
The report concludes that individual traders, rather than index traders, have been the driving force behind the increase in open interest for cotton futures and options.
Another interesting observation of the report is that net positions (the difference between long and short positions) held by index traders remained positive and more than doubled between January 2006 and February 2008, indicating bullish sentiments among these speculators.
On the other hand, the net positions held by individual traders showed great variability around zero until June 2007, when they turned positive and increased thereafter.
Therefore, individual speculators have been instrumental in increasing total (individual and index traders’) net speculative positions since June 2007, placing upward pressure on nearby cotton futures prices. Analysis of data relating to changes in speculative positions (both individuals and index traders) and changes in Cotlook A-Index (a measure of global cotton prices) establishes a causal relationship between net long positions and Cotlook A-Index.
The report infers that bullish sentiment among individual speculators has contributed to pushing cotton prices up, above and beyond what fundamentals suggest as appropriate.
Of little surprise
For those tracking commodity markets, this conclusion should bring little surprise. Speculators enter a commodity market whenever they see an emerging demand-supply mismatch.
Their trading positions would reveal not what current market fundamentals are, but expected changes in the future. It is in anticipating future changes and taking a trading call today that savvy speculators thrive.
A look at the demand-supply fundamentals of the global cotton market for three years reveals tightening market conditions. Output trails consumption and stocks have been drawndown considerably, providing a fertile playing ground for speculators. In a tightly balanced market, even a small change in either demand or supply or both will have a disproportionately large impact on prices.
In a rising market producers usually do not hedge the entire production as they would be reluctant to lock-in profits (which is what hedging is all about), and would want to keep the potential profit open-ended.
Consumers have surely suffered because of the rise in physical market prices.
The world financial markets are awash with excess liquidity. Speculators (who these days are euphemistically called investors) are constantly looking for new investment opportunities with potential for quick and high profits. Commodities have recently emerged as an asset class.
But the speculative play in the market has the potential to adversely affect genuine physical market participants such as primary producers and processors.
ICAC should be complimented for conducting this research which has brought out the role of speculators in the commodity market.
ICAC would do well to extend the study to ascertain the types of market participants who have actually benefited and who have suffered because of rising speculation. For India, there are lessons to be learnt.
The market is currently ruling significantly higher than price forecasts made by several analysts and trade experts. That the price behaviour beat expert forecasts seems to have surprised a lot of people including market participants.
While primary producers and exporters have reason to be happy with rising cotton prices, consumers are not.
India is no exception. Despite large production (over 30 million bales in 2007-08 representing 10 per cent increase over the previous year), cotton prices in India too have remained firm, well supported by strong exports.
What has led to the price spurt in recent weeks?
Rise in long positions
A research paper titled “Speculation and Cotton prices” prepared by Alejandro Plastina, Economist with the Washington-based International Cotton Advisory Committee (ICAC) has, based on analysis of data, showed that speculators have played an important role in pushing prices higher.
According to the research, speculators have accounted for increased share of cotton long positions.
Long are those who buy today with expectation of a price rise at a future date. They would sell and book profit when the price objective is achieved.
Pointing out that Open Interest in cotton futures and options contracts more than doubled between January 2006 and February 2008, the author goes on to state that the share of total long positions in the ICE (New York Board of Trade) cotton futures and options market held by hedgers declined from an average of 31 per cent in 2006 to 27 per cent in 2007 and further down to 26 per cent in 2008.
The counterpart of the decline in the share of total long positions held by hedgers was the increase in the share of total long positions held by speculators (individuals and index traders) from 69 per cent in 2006 to 73 per cent in 2007, and then on to 74 per cent in 2008.
Analysing the composition of speculators long position, the research found, individual traders, rather than index traders, accounted for an increasing share of long positions held by speculators, from 50 per cent in 2006 to 61 per cent in 2007 and then on to 65 per cent in 2008.
On the other hand, the share of index traders (pension funds, managed funds, and other traders with predominantly long futures positions replicating commodity indices) declined from 50 per cent in 2006 to 39 per cent in 2007, and then on to 35 per cent in 2008.
The report concludes that individual traders, rather than index traders, have been the driving force behind the increase in open interest for cotton futures and options.
Another interesting observation of the report is that net positions (the difference between long and short positions) held by index traders remained positive and more than doubled between January 2006 and February 2008, indicating bullish sentiments among these speculators.
On the other hand, the net positions held by individual traders showed great variability around zero until June 2007, when they turned positive and increased thereafter.
Therefore, individual speculators have been instrumental in increasing total (individual and index traders’) net speculative positions since June 2007, placing upward pressure on nearby cotton futures prices. Analysis of data relating to changes in speculative positions (both individuals and index traders) and changes in Cotlook A-Index (a measure of global cotton prices) establishes a causal relationship between net long positions and Cotlook A-Index.
The report infers that bullish sentiment among individual speculators has contributed to pushing cotton prices up, above and beyond what fundamentals suggest as appropriate.
Of little surprise
For those tracking commodity markets, this conclusion should bring little surprise. Speculators enter a commodity market whenever they see an emerging demand-supply mismatch.
Their trading positions would reveal not what current market fundamentals are, but expected changes in the future. It is in anticipating future changes and taking a trading call today that savvy speculators thrive.
A look at the demand-supply fundamentals of the global cotton market for three years reveals tightening market conditions. Output trails consumption and stocks have been drawndown considerably, providing a fertile playing ground for speculators. In a tightly balanced market, even a small change in either demand or supply or both will have a disproportionately large impact on prices.
In a rising market producers usually do not hedge the entire production as they would be reluctant to lock-in profits (which is what hedging is all about), and would want to keep the potential profit open-ended.
Consumers have surely suffered because of the rise in physical market prices.
The world financial markets are awash with excess liquidity. Speculators (who these days are euphemistically called investors) are constantly looking for new investment opportunities with potential for quick and high profits. Commodities have recently emerged as an asset class.
But the speculative play in the market has the potential to adversely affect genuine physical market participants such as primary producers and processors.
ICAC should be complimented for conducting this research which has brought out the role of speculators in the commodity market.
ICAC would do well to extend the study to ascertain the types of market participants who have actually benefited and who have suffered because of rising speculation. For India, there are lessons to be learnt.
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