Soon, your next door neighbor -and why not yourself- is going to be feeling that his/her paycheck is falling short. Come this winter, there is a chance that “anything cotton” will be substantially more expensive. No problem for the man, but wives’ budgets might be going up more than what husbands will be comfortable with. The reason being is that cotton prices have been rising steadily for over a year and more recently are near the peak not seen in the last 15 years. A testimony to this can be seen in the rising chart for BAL, an ETN which seeks to replicate the return of the iPath DJ-UBS Cotton TR index.

Some ETNs can be seen as proxies to commodities. They are structured products that are issued as senior debt notes by Barclays. ETFs, instead, represent a stake in an underlying commodity. ETNs carry no distribution and are mathematically less prone to errors when compared to ETFs. ETNs must be thought of as prepaid contracts that generate profit and losses by the difference between the sale and the purchase. In the specific case of BAL, the underlying index aims at maximizing the potential return by taking unleveraged positions in cotton futures contracts.

But none of this answers the question of why cotton prices have been rising. Weather related problems have been a big part of the story. Pakistan, the 4th largest producer after China, India and the US, has seen its crops devastated by floods. Russia, another major producer also took a hit from fires and drought conditions. In addition, the National Cotton Council estimates that part of the price increase is due to a rise in consumption globally. This is important, as the same trends may show up in other commodities from grains -wheat, soybeans- to sugar.

According to the USDA this will be the 5th year where demand supasses supply. The global demand for cotton had seen its peak in 2006-07 at 121 million bales and has come down to 110 million bales recently. But as the recession subsides, numbers are on the rise again. Joe Nicosia, CEO of Allenberg Cotton Co., thinks that “…in 2010-11, December 2010 futures may trade in the low 70s, we think U.S. acreage will begin to recover. We’re projecting U.S. production in 2010-11 to rise to 16.3 million bales, which would lead us to a carryout under a recovery scenario of just over 3 million bales. If the market were to move 10 cents higher, we estimate this would bring in an additional 6 million acres around the world. This would be more than necessary to meet any kind of recovery and put a cap on prices going out into the deferred months.”

Source: CBSlocal.com

In the meantime, traders expect prices soon to normalize and while you and I may still have to pay a premium for buying new T-shirts and jeans, I am positive there is a farmer in Memphis, Tennessee that will be enjoying a great Christmas this year.

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