Investing in cotton has become one of the most talked about investment options in just the last one to two years. While most investors were still unaware of this specific commodity prior to 2010, interest has soared following the historic price increase for cotton which started in 2009. Correspondingly, ETFs tracking the price of cotton have appeared on the market which provide an opportunity for the individual investor to participate in the cotton market. We will take a look at the basics for this commodity, the investment case and the specific ETF investment options.
Cotton – a Basic Commodity With Many Uses
Cotton is harvested from plants grown in warm, subtropical regions around the globe. It is considered to be a “soft” commodity along with similar agricultural products like sugar, coffee or cocoa. Its main use is within the clothing industry, however, several industrial uses requiring cotton as a raw material also contribute to the overall demand for this commodity.
The three largest producers of cotton worldwide are China, India and the United States, in this order. A curious fact which has a strong influence on the global cotton market is that China, as the largest producer, is an even larger consumer of cotton, turning the country into a net importer. Consequently, India and the United States of the world’s largest cotton exporters.
The Cotton Investing Case
Like most other commodities, cotton has seen a strong price increase in 2009 and 2010. In fact, prices are now at historic heights, unseen in recent decades. While the price increase of most other commodities has slowed down in 2011, cotton has continued its upward trend, leading to an overall price increase of more than 200% compared to 2008. The reason for this price increase is a strong and growing Chinese demand, coupled with ongoing supply constraints due to unfavorable weather conditions in the largest producer nations. Additionally, the amount of land used for growing cotton has constantly decreased for almost three decades now, further limiting the amount of cotton available in global markets. Combined with the fact that cotton is a product with one of the longest “lead times” of all commodities -it takes more than one and a half years from the seed to the finished cotton product- this makes quick increases the global supply unlikely.
The future development of cotton prices therefore depends almost solely on the direction the Chinese demand will take. Naturally, a price rally such as the one experienced by cotton leads to a high volatility and big price swings, making cotton ETFs some of the most volatile funds on the market. Consequently, many investors believe that an at least temporary drop in prices is to be expected in the near future, making short cotton ETFs a much sought-after alternative.
The Cotton ETF List
Several investment options exist for targeting the cotton market. All of them are based on future contracts for trying to replicate the time development of the cotton market price. Three “ETF-like” securities exist which exclusively hold cotton futures in their portfolio, of which two are traded on US stock exchanges. Another ETF with a significant cotton exposure completes the list.
- The Dow Jones-UBS Cotton Total Return Sub-Index ETN (symbol: BAL) tracks a single cotton future and is the largest exclusively cotton-focused fund on the market with a market capitalization of about $50 million. As an exchange-traded note (ETN) it is not a true ETF, but a debt obligation by the fund issuer.
- The Pure Beta Cotton ETN (symbol: CTNN) is another ETN which exclusively tracks an index based on cotton futures. At a much lower market capitalization of about $5 million, it has received less attention than the more well-known BAL.
- The ETFS Cotton (symbol: COTN) issued by ETF securities also tracks cotton futures. It is set up as an exchange-traded commodity (ETC) which like ETNs is in reality a debt obligation by the issuer. The ETFS Cotton fund is traded on the London Stock Exchange in the UK.
- ETF securities also offers a short cotton ETF to profit from falling prices. Called the ETFS Short Cotton (symbol: SCTO) it is set up in a similar way to the COTN fund as an exchange-traded commodity and is also traded on the London Stock Exchange.
- Finally, the Dow Jones-UBS Softs Total Return Sub-Index ETN (symbol: JJS) is a soft commodity fund with an exposure to cotton futures of about 1/3 of its portfolio, with sugar and coffee making up the rest.