Cotton-Eyed Joe: The Fundamentals on Cotton Remain Weak

Cotton Eyed Joe is an American folk song that pre-dates the civil war. As it turns out, Cotton-eyed actually has nothing to do with cotton, but actually is believed to mean drunk on moonshine. The expression is likely most famous for its use in the Alabama song, “If You’re Gonna Play in Texas”. That line is as follows:

“I remember down in Houston we were puttin’ on a show when a cowboy in back stood up and yelled, Cotton-eyed Joe.”

At Research Edge, we don’t come to work Cotton-eyed (except for maybe the morning after the firm holiday party), but we do, in fact, have our Eyes on cotton.

Brian McGough, who is the Director of Research and Footwear and Apparel Analyst, recently sent a note to his clients highlighting the year-over-year declines in cotton pricing. His point, as it related to his coverage universe, was as follows:

“All in, let’s not forget that cotton accounts for about $5 in costs for a $100 garment at retail. We can debate up and down where in the supply chain any cost saves would show up – but quite frankly, I really don’t care at this point. We’ve had a 1.5 year cost headwind that is starting to ease on the margin. This will help everyone to some degree. It pains me to say this, because I have zero confidence in management or company strategy, but Gildan would be a disproportionate beneficiary to the reduction in cotton costs given that cotton is 35% of its COGS. If you want to play in that sandbox, then knock yourself out. I’m sticking with the winners like RL, HBI, UA (though it has zero cotton exposure – it competes with those that do), and LULU.”

The USDA announced last week that US cotton exports were up 23% for the week ending March 4th, which implies demand may be picking up. That said, the news from China continues to be bearish for cotton as noted by the U.S. Department of Agriculture: “China’s imports of cotton in the year through Aug. 31st may halve to 6.5 million bales from a year ago.” The most recent data point from China, released by the National Development and Reform Commission, was that China imported 93,000 tons in February, which was down 41% y-o-y. Since China is the world’s largest cotton importer, this data is very bearish as it relates to global cotton supply and demand, and future cotton prices. As outlined above though, low cotton prices are bullish for the margins of certain apparel manufacturers.

While the price of cotton appears to be troughing, we will need to see some sustainable fundamental evidence that supports either increasing demand, or decreasing supply, that will support a sustained price increase. As such, cotton may be a commodity to play on the short side against other commodities that will be more direct beneficiaries of the re-flation theme. This potential negative divergence in cotton is notable today with natural gas up 10.4%, West Texas Intermediate up 6.3%, gold up 7.7%, copper up 5.1%, silver up 13.9%, and cotton only up 2.95%.

We are currently long Oil via the etf USO and long the etn DJP, which mirrors the iPath Dow Jones-AIG Commodity Index.

Daryl G. Jones
Managing Director

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