Soft commodity traders could be hung out to dry

GROUPS of older ladies like to coo over small children’s cotton socks, otherwise this soft commodity didn’t use to cause too big a stir. That is until now: in the last month the price has broken from a three-decade range, rocketing to $2 a pound – that is a 40 per cent increase since January. This has got clothing retailers everywhere debating whether they should absorb the price or pass it on to the customer. They – like contracts for difference traders – are desperate to know how much longer this historic price climb can last.

The chart below shows the extent of the rally. Even the most hardened traders are surprised. David Jones of IG Index says: “It is something of a runaway trend at the moment. The price looks overextended – but you could have said that at any point over the last few weeks, so it might just keep going up.”

Michael Hewson of CMC Markets shares some of Jones’s thoughts: “The bad harvest, the inflationary effects of quantitative easing, and a little bit of speculator action have pushed the cotton price sky-high. Much like it has across the majority of commodities.”

Dylan Grice of Societe Generale thinks the climb should be put into context. He says: “Commodity bull markets have been much like England football managers: they promised much, burned brightly for a while, but ultimately crashed, breaking the hearts of those who believed in them most.”

He refers traders to the trends in commodity prices since 1800s: the majority of markets have consistently declined in value with only the occasional spectacular bull market followed by an enormous crash. He warns that only highly-skilled traders can pick the top and bottom of these dramatic markets.

Consider the last tremendous rally in cotton in the 1860s. This was caused because America (one of the biggest producers at the time) banned exports during its civil war, creating a worldwide cotton famine. This sent prices soaring until other areas of the world began producing their own cotton. This caused the price to dive back into the gradually-declining range that it has maintained until now.

Bold and skilful traders might like to chase the price climb and attempt to pick a top. But if they miss it they could find themselves the market equivalent of a long-suffering English football fan. A tragic fact, especially when you realise that only footballers can afford cotton socks in the meantime.