Author: John Robinson

It is commonly assumed that a stronger U.S. dollar is a bearish influence on export commodities like cotton.  While that is often true, it is not quite that simple.  Figure 1 compares the inverse pattern of “nearby” (i.e., soonest to expire) ICE cotton futures prices (in red) and an index (in blue) of the U.S. dollar relative to a basket of six currencies: the Euro, Japanese yen, British pound sterling, Canadian dollar, Swiss franc, and the Swedish krona. Those six countries and their currencies have little to do with international cotton exports or imports. However, to the extent that U.S. dollar strength (for whatever reason) against these currencies coincides with U.S. dollar strength versus cotton exporting countries (e.g., Brazil, Australia, Central Asia, and sometimes India), then this chart may reflect situations where a strengthening dollar is directly associated with lower U.S. export competitiveness. The lower U.S. export competitiveness could transform into lower U.S. domestic cotton prices.  As a result, we see an inverse pattern in Figure 1. However, there are periods of time reflected in Figure 1 where the inverse relationship breaks down, e.g., in the center of Figure 1 during 2013. That period coincided with a time when European sovereign debt was weakening the euro relative to the dollar, which represents a distortion to what this chart is trying to explain. 

Figure1. U.S. Dollar Index versus Nearby ICE Cotton Futures Settlement Price

A potentially cleaner comparison would be of the U.S. dollar versus the Brazilian real or the Australian dollar.  The more cotton-specific impact of the U.S. dollar value on U.S. exports can be inferred from USDA trade-weighted exchange rate indices.   Looking back at these kinds of indices will show time periods like, for example, in 2015 when the U.S. dollar got 6.4% stronger (year-over-year) compared to the currencies of the specific countries that we trade cotton with.  This means that U.S. cotton was roughly that much more expensive to foreign buyers compared to other cotton exporting countries.

Lastly, to the extent that large financial institutions (investment banks, hedge funds) are moving money across asset classes, a rise in the dollar could reflect a risk off shift of investment out of stocks and commodities (driving down cotton futures, all other things being equal) and into U.S. treasuries. This would presumably be reflected in a rising U.S. dollar. Parts of Figure 1 may be explained by such movements, and they have little to do with cotton economics or export competitiveness.

Robinson, John. “The U.S. Dollar’s Influence on ICE Cotton Futures“. Southern Ag Today 2(4.1). January 17, 2022. Permalink

Squeeze situations in financial markets have been in the news this year.  In early 2021, the stock of the company GameStop was subject to extreme price volatility as a large number of short sellers were forced to buy back their positions while other traders were buying the stock aggressively.  Squeeze plays exist in commodity futures markets, too.  A common example of this can happen with short speculators in a rising futures market.  Assuming those speculators can’t deliver the physical commodity against their short futures position, they are left having to buy their way out of their short futures position, which contributes to upside price volatility.   

A different version of this short squeeze situation is playing out in ICE cotton futures in the current marketing year.  The set-up for this situation involves a number of things.  First, there is a physical supply imbalance in the form of the very low level of physical “certified stocks” of cotton that are eligible for delivery against ICE cotton futures contracts, as shown in Figure 1.  Daily certified stock levels are published daily by the ICE.  

Second, there is a historically high level of “unfixed call sales” contracts, especially on the Mar’22, May’22, and Jul’22 cotton contracts.  Unfixed call sales represent un-finalized basis contracts between merchants and mills which will eventually require buying of futures to fix the price. This situation is reflected by weekly data published by the U.S. Commodity Futures Trading Commission.  

Third, there is also historically large, long speculative positioning in ICE futures, including both hedge funds and index funds.  With the current expectations for rising inflation, speculators who are long cotton futures may hang on to, or even expand their long futures position in ICE cotton.  This could lead to continued futures price volatility, especially during February, April, and June. 

Chart Source:  Author compiled with data from USDA Ag Marketing Service (https://www.ams.usda.gov/market-news/cotton-tobacco ) and cotton certified stocks from the Intercontinental Exchange (https://www.theice.com/marketdata/reports/4/product/588/hub/732/isOption/false/isSpread/false ).

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Robinson, John. “Current “Squeeze” Dynamics in ICE Cotton Futures.” Southern Ag Today 1(50.1). December 6, 2021. Permalink

Cotton futures, like many commodities, are subject to speculative buying and selling.  Participants in the futures market can buy or sell futures contracts with the anticipation of future prices rising or dropping. The most variable type of speculative buying is from so-called hedge funds, comprised mostly of managed private investment money. Hedge funds use various quantitative and other methods to position themselves for anticipated uptrends or downtrends in commodity markets.  Notwithstanding the validity of their technical indicators or buying rules, hedge fund buying appears somewhat influential on prices, particularly ICE cotton in 2021. 

This is depicted in Figure 1 as the upward spikes in the green area, representing the excess of long ICE cotton contract positions (buying positions) held over short positions (selling positions) held.  These green peaks and valleys visually correspond to peaks and valleys in the pattern of nearby ICE cotton futures settlement prices as represented by the red line (Figure 1).  Statistically speaking, simple annual cotton futures price models can be specified to account for the influence of things like USDA’s projected ending stocks-to-use ratio, the speculative net position of hedge funds (in contracts), and outlier years like 2010/11.  The results of these types of models tend to project slightly less than a cent up or down, resulting from a 10,000 contract increase or decrease, respectively, in the hedge fund net long position.  In 2021, from early June to early October, the hedge fund net long position has risen almost 60,000 contracts, which is associated with about six cents of the 24+ cent upward move in ICE cotton futures since June.  (Note:  other potentially influential variables in 2021 include tightening fundamentals and increased index fund buying are not included in the analysis here).

Whatever the quantitative influence of changing hedge fund positioning, it may be useful to take note of the short duration of fluctuations in hedge fund excess buying.  Figure 1 shows many instances of peaks in hedge fund buying that appear to last only a few weeks, as do the associated price rallies.  It seems impossible to predict the change in sentiments, animal spirits, model forecasts, technical indicators, and/or black swan events that will influence hedge fund managers’ positioning in ICE cotton.  So, whatever the influence of hedge fund buying on the cotton market, it is frequently a short-lived phenomenon.

Figure 1. Weekly net position of hedge funds in ICE Cotton Futures and Options (green area) and daily nearby ICE Cotton Futures settlement price (red line). The left vertical axis represents the net position of hedge funds, and the right vertical axis represents the price for the ICE cotton futures settlement prices. 

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Robinson, John. “Speculative Influence on ICE Cotton Futures.” Southern Ag Today 1(45.1). November 1, 2021. Permalink