Cotton Futures

There are two words that any commodities investor loves to hear – “supply shortage.” For years, they’re marked the turnaround period in a commodities and futures investment campaign; the one moment when an investment that may have been losing money for several years, is turned around and becomes a leading income producer for the investor, a financial firm, or an individual trader.

Supply shortages happen relatively infrequently, at least in the same industry. When production is at a low level and buyers somewhat spread out and equally demanding, it’s a long-term sign that things really do need to change. And as a result, a supply shortage that proves lucrative for investors once, may not end up occurring again for several years – often even several months – at a time.

This makes a single supply shortage a relatively valuable experience to commodity investors, as an isolated supply shortage can produce truly massive returns on investment. It also serves as a sign to diversify their commodity holdings, often away from contracts in this industry, as the likelihood for things to change dramatically in the future grows significantly with each signal of struggling supply.

For the last few months, one commodity has been caught in a state of near permanent shortage. It’s cotton, and it’s become an investor’s dream. The material that everyone knows and loves is a staple for clothing and product manufacturing around the world, and one of the most versatile materials in our industry. It’s also come off an eight-week supply shortage, leading to renewed production.

But let’s look before the increased supply resulted in a leveling-off of prices. Let’s look at cotton at its peak, to assess how valuable commodities such as cotton futures can be. Cotton futures may not be at the top of the investment food chain today, but they’re an example of what can happen when a valuable commodity – one that the world requires – hits a peak in its production to supply ratio.

Bloomberg reported a constant seven-day increase in the value of cotton during early March this year, a stunning increase even for those well versed in financial circles. The commodity is seeing increased production now, but it took the world a long time to act. Before prices decreased due to news of renewed production, cotton held the longest commodity future price rally in a year.

The reason? Scarcity and its effects on the ratio of cotton supply to demand. While many investors overcomplicate the futures market with complex charts and difficult calculations, it’s really just the natural market forces at work. When supply decreases next to increased demand, prices for futures contracts for the ‘hot’ commodity of the moment shoot upwards, taking their investors with them.

That said, it’s important to establish the limits for commodity price growth. Cotton, on most of the world’s exchanges, is limited to a price increase or decrease of five to seven cents daily. This is for eliminating the potential negative effects of a rapid increase in price on the market – when values, particularly for essential commodities, rise quickly, it can result in adverse effects for the market.

For some commodities, of which cotton is one, the price modification range changes as the price of the futures contracts increase further. This means that when cotton is valued highly – either due to a limited amount of supply or greater demand at the same supply level – the amount that contracts are able to rise or drop in value daily increases further, in this case to a trading limit of seven cents.

In total, cotton futures grew over 160 percent throughout the last twelve months – a stunning rise for the investors involved in the cotton futures market. It’s important to see this growth as a major event not just for cotton, but for commodities in general. This same type of explosive growth can happen for any high-demand commodity, and it needn’t be an investment in cotton that causes it.

It’s worth noting that, despite the explosive growth of many commodities futures, there are barriers to becoming a futures investor yourself. Many contracts have minimum delivery requirements, that effectively limit small-volume investors to enter the market. While there are ways around these, it’s generally a big player’s game, at least in the markets that offer the possibility of explosive growth.

Then there’s the obvious risk that’s involved in investing in any commodity futures contract, cotton in particular. In periods where demand is limited and supply is relatively high, the opposite result is likely to occur. Buying cotton futures isn’t buying a ticket to rapid value gains and wealth – it’s just a ticket to the possibility of this type of event pushing the price of a commodity up once again.

Cotton futures illustrate an important point that’s very possible for almost any form of commodities futures investment – explosive growth does happen, and it’s a possibility for every investor. But just because explosive growth occurs to one type of commodity – in this case, one with large amounts of demand across the world – it doesn’t mean it’s a given factor for purchasing any futures contract.

Look at the current state of cotton for what it is – a high point that can occur with any commodity, yet needn’t become a lasting reality. Prices will rise and fall, not just for cotton, but for a range of futures contracts. The key is in being there to arbitrage that price increase and subsequent decrease – that’s the position any long-term, intelligent investor wishes to be in.

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