Cotton ETF (BAL) Skyrockets On Chinese Demand, Australian Crop Concerns

by on February 17, 2011 | ETFs Mentioned:

It’s hard to argue that 2010 was the year of the commodity, as products ranging from gold to oil and everything in between saw their prices surge on the back of rising fears over inflation and supply concerns for many of the world’s key soft commodities. However, the pace of gains has slowed considerably in 2011 for most commodities except for one; cotton is continuing its unprecedented surge higher this year as well.

Cotton, a crucial commodity for textiles around the world, started 2010 around 75 cents a pound and after moderate gains in the first half of the year, took off in the second half of 2010, surging to $1.76 a pound. While some thought that the commodity was due for a pullback after these incredible gains, the fluffy commodity merely continued its run up to current prices above $2/lb. instead. This incredible surge came about early in Thursday trading as cotton for May delivery hit the circuit breaker with a gain of seven cents, or roughly a 3.6% surge for the session, a level that pushed the fluffy commodity above the two dollar level for the first time in history [read Commodity ETFs Get No Love From Investors].

While the market for cotton may have shut down in the early part of trading, the main ETN tracking the commodity, the iPath Dow Jones-UBS Cotton ETN (BAL) didn’t have to worry about hitting a circuit breaker and kept right on trading throughout the session. As a result, BAL adopted the role of ‘price discovery mechanism’ allowing traders and investors to determine the fair value of cotton given the new information hitting the market. Due to this, BAL was experiencing extremely heavy volume–trading was already exceeding quadruple the daily average with several hours left in the session–and was skyrocketing higher by close to 7% at time of writing [see Commodity ETF Ideas: Profiting From Backwardation].

These incredible gains were largely the result of two factors; Chinese demand and Australian supply, both of which favored the bulls heavily in today’s session. A recent report stated that China will consume 47 million bales of cotton for the year that began August 1, far exceeding its domestic production of 30 million bales. Due to this, analysts look for global stockpiles to reach their lowest level since 1996, according to the USDA. Meanwhile, in Australia, severe flooding has devastated a variety of that country’s commodities with the fragile cotton being one of the worst hit. The nation, which is the fourth largest producer of the crop, lowered its production estimates by nearly 4% earlier in the week, further fueling markets in today’s session. Traders took these two events, as well as cotton’s recent history and concerns over future supplies, to propel cotton and BAL to unprecedented heights in Thursday trading. “The bulls have gone berserk, and it looks like they want prices to go higher,” said Sid Love, the president of Joe Kropf & Sid Love Consulting Services LLC. “China’s demand still remains strong.” [also read Five ETFs Heavily Dependent On China]

Unstoppable Cotton

Today’s gains only further the incredible run that BAL has returned to investors over the past year; the fund is now up a mind-blowing 204% over the past 52 weeks, close to 171% over the past half year, and 52% so far in 2011, far and away the best performer in the Commodities ETFdb Category. While no one knows what the future holds for BAL, a volatile path seems all but guaranteed, especially given the fund’s incredibly high historic levels of volatility; 885% for the 30 day measure and 1,766% for the 200 day version. As for continued gains, that is another story that remains up for debate among traders in the sector who are likely to focus in on Australian production and any attempts by the Chinese government to slow down the national economy to a more manageable level. Either way investors should stay tuned to see if cotton’s meteoric rise can continue or if it will crash back down to earth later this year. “The recent momentum has been undeniably bullish,” Luke Mathews, a commodity strategist at Commonwealth Bank of Australia said. “Considering that we have hit this $2 mark, which is where many people are suggesting the near-term target in the market was, where do we go from here? It’s really an uncertain environment.”

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Disclosure: No positions at time of writing.