On Monday, India announced that, effective immediately, cotton exports would be prohibited. This is a big deal, as India is the second largest exporter of cotton, and the last time they did this, Cotton spiked to 30+ year highs:
Cotton Prices Feb 1982 - Jan 2012, IndexMundi.com
According to the Financial Times:
India’s last export ban, declared in 2010, helped ignite an explosive rise to record highs in cotton markets. Farmers and later mills defaulted on deliveries as prices climbed and crashed, causing losses or poor results for global commodity merchants including Glencore, Noble, Olam and Cargill.
When cotton spiked in 2010/11, a number of retailers’ gross margins took it on the nose. At the time, I was tracking The Gap (NYSE: GPS), Aeropostale (NYSE: ARO), and American Eagle Outfitters (NYSE: AEO) quite closely and the price of cotton was dominating the conference calls. Making matters worse was the fact that these retailers all succumbed to the market’s headfake and, believing a strong recovery was underway, loaded up on inventory. Expensive inventory, since cotton had skyrocketed. When demand did not materialize and the recovery turned out to be far weaker than expected, retailers got crushed.
Now thankfully last year’s shock taught retailers a lesson in black swan events, and they adjusted accordingly. Inventories have shrunk back to normal levels, and the cotton content in clothing has been reduced in favour of synthetic fabrics. So, all in all we shouldn’t expect the same level of margin compression if cotton once again spikes.
On a side note, it appears that India’s move is to counter China’s hoarding of Cotton for what I’ll call its “strategic cotton reserve:”
India’s decision came as China, the world’s biggest consumer, in the past year has aggressively bought bales for a government reserve as a way to support domestic farm prices and buffer against price volatility.
By late January, China had bought as many as 5m bales of foreign cotton for the reserve, which along with its domestic purchases made up 15 per cent of global cotton consumption in the current crop year, the US Department of Agriculture estimated.
India noted what it described as “a tendency of hoarding in bonded warehouses abroad” as export registrations jumped to 12m bales, well above its estimated exportable surplus of 8.4m bales.
Interesting world we live in…
Disclosure: Long ARO
