Eye on Cotton

Cotton prices are down roughly 10% over the last 10 sessions to $0.55/lb., though there’s enough vulnerability in the supply chain whereby meaningful weakness through year-end might be tough for the bears to bank on. Heading into ’10, this translates to ‘long pricing power’ and short commodity exposure. 

Stockpiles:  The most recent data point from China, released by the National Development and Reform Commission, was that China imported 131,400 tons in July, which was down 38% yy albeit a slight improvement from 41% yy declines in the 1H. This has led to a tightening of world stocks as reflected in a global stocks-to-use ratio of 51.0% in August down from 51.3% in July. In addition, there has been recent speculation that China might increase cotton volume import quotas over concerns that state stockpiles will not be able to supplement the shortage of supply. Since China is the world’s largest cotton importer, this could be bullish as it relates to future cotton prices.

Production: Global production levels are down with the U.S. at its lowest level in 11 years and estimates for India’s output (world’s second largest producer) is down 15-20% because of drought conditions.

Demand: We’re not making a bull case around global consumer demand, but we find it very difficult to make a compelling bear case. Inventories in the global system of both raw and finished product remain fairly low, healthy, and in synch with current consumer demand. Looking at all the different scenarios, we think it’s more likely than not that demand moves up over the next six months. Inventories are tight around holiday, and then wer’e looking at spring/summer ’10 where we comped against not only a horrible recession, but a weather-impacted period where many consumers simply extended the prior year’s wardrobe. There’s going to be pent up demand at some point.

If we actually start to emerge from this global recession with cotton stockpiles low, production down, and demand picking up on the margin, I’d hate to be on the short side of cotton exposure.

Of course, the theme here will be long pricing power (brands and large retailers), and short commodity exposure (Gildan and to a lesser extent Hanesbrands). It’s too early to see this play out in 2H09, but it will be an increasingly important theme in 2010.

Eye on Cotton - cf cotton 8 09