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By Don Miller

Reacting to a potential squeeze that threatens to drive up cotton prices, the biggest cotton-futures exchange took measures last week to prevent speculators from taking big positions.

The IntercontinentalExchange Inc. (ICE) is increasing scrutiny on speculators amid soaring demand that has nearly tripled cotton prices in the last 12 months, threatening the profits of mills, commodity suppliers and apparel producers.

Growing demand for the fiber, particularly from China, has raised fears of shortages this year. Low global stocks and torrential rains in Pakistan and India, the second-biggest grower, as well as recent floods in Australia have added to the concerns.

The number of cotton contracts outstanding has grown by 21% in the last year, boosted by an influx of hedge funds and small speculators.

The squeeze could come in the next few weeks as cotton mills are holding contracts to buy cotton under the March contract, which expires on March 9.

Under normal circumstances, they would have already locked in a price for that cotton. But as prices kept soaring, many held off, hoping for lower prices that never came, according to a report in The Wall Street Journal.

The fear is that speculators could put the squeeze on the mills by buying up cotton, driving prices even higher. In response, ICE on Thursday said it would start to require buyers taking big positions in the cotton markets to justify a need.

Between now and March 9, market participants wanting to hold more than 300 contracts, the equivalent of 30,000 bales, must request approval and prove they have an economic need for the cotton, The Journal reported.

"Cotton is a mess. It's moving so quickly, predominantly up. Every day you pass thinking you are going to see something better, you risk missing out on cotton all together. If you don't take cotton today, your costs are escalating and you are under water pretty quickly," Tracy Linton, vice president of Galey & Lord, a textile mill based in Society Hill, S.C. told The Journal.

While this rule is new to the cotton market, it is has been regularly enforced across other agricultural products.

Regulators take a dim view of excessive speculation in commodities markets, arguing that it can distort prices and make it harder for producers and users of commodities to manage their risk. They say it also may negate fundamental investment factors like supply and demand.

Traders point out that there is no data to prove such activity can artificially inflate prices in the commodity markets.

But new limits on speculators have been gaining favor around the globe as prices for everything from soybeans to copper set records.

Among the notable gainers last year were gold, which gained 30% in 2010, and silver, which gained 83%. Agricultural commodities also jumped in 2010, with wheat climbing 47% last year, while corn rose 52% and cotton advanced nearly 92% in 2010.

Civil unrest in North Africa and the Middle East has governments on edge as they fear a repeat of the food crisis of 2008, which saw violent protests in developing countries around the world.

Last Wednesday, the European Commission, which writes laws for the region's 27 countries, published an outline of plans to clamp down on speculators.

"Between 2002 and 2008, the number of financial contracts for derivatives in commodities has tripled," Michel Barnier, the commissioner in charge of EU financial reform told Reuters. "We are no longer talking about foodstuffs. Agricultural products are turning into financial assets."

Barnier wants to increase the powers of regulators to intervene in the markets when speculative positions in derivatives - the value of which is tied to a commodity - send grain or energy prices soaring.

Europe's concern followed actions by the U.S. Commodity Futures Commission (CFTC), which proposed a rule on Jan. 13 establishing limits on positions in physical commodity futures contracts designed to combat excessive speculation and manipulation in commodity markets.

The proposed rule, which also covers swaps that are economically equivalent to those contracts, could govern trading in 28 commodities - 19 agricultural contracts, four energy, four precious metals and one base metal contract.

"Position limits help to protect the markets both in times of clear skies and when there is a storm on the horizon," said Gary Gensler, chairman of the CFTC. "Today's proposal would implement important new authorities in the Dodd-Frank Act to prevent excessive speculation and manipulation in the derivatives markets."

The proposal was formally introduced by a 4-to-1 vote. Interested companies and traders will have at least 60 days to comment on the proposal before Gensler can bring it before the commission for a final vote.

Although the limits were written into the Dodd-Frank financial overhaul mandated by Congress last summer, a majority of the CFTC's five commissioners must still vote to finalize the rule sometime after the comment period ends.

Source: Speculators Sanctioned Amid Soaring Cotton Prices