As China Sends Cotton Toward Bear Territory, U.S. Apparel Firms Become Pressured

Includes: BAL, HBI, MFB, ZQK
by: Matt Schilling

On Friday, China had fulfilled its intention to release a portion of the cotton it had held in its state-based reserves. Many analysts believe the move could potentially create a shift in the global markets in which the fiber is traded. This move however, should not come as surprise, as it was disclosed that China may very well look to release its reserves back on December 28th.

Contracts for March delivery fell as much as $1.39, or 1.85%, to $74.00/contract during intraday trading on the ICE Futures U.S. Exchange. Its purchases of U.S. cotton had supported futures prices. If China continues to sell cotton from its reserves, such transaction could result in lesser demand for U.S. cotton.

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According to John Flanagan, president of Flanagan Trading in Fuquay Varina, N.C., "The release of cotton from China's reserves "would be bearish to cotton futures, but we suspect they will only sell small amounts until after planting season passes in the late spring". On the other hand, if China releases a majority of their cotton reserves, domestic prices could falter and discourage U.S. farmers from planting the crop.

For U.S.-based investors of the iPath Dow Jones-UBS Cotton Total Return Sub-Index ETN (NYSEARCA:BAL), I think Friday's negative session (and slight indication of a potential bear market) may be enough indication to take profits or eliminate one's position all together. Continued pressure on U.S. farmers as result of China's release of inventories could affect the bottom line of such companies as Hanesbrands (NYSE:HBI), Madienform Brands (NYSE:MFB) and Quiksilver (NYSE:ZQK). All three of these companies use cotton throughout their apparel portfolios and if access to cotton becomes limited or more expensive due to import and export costs, revenues will clearly be affected.

Final Analysis

The 2013 market outlook for Cotton seems quite bearish. According to an article written by Mamta Badkar of Business Insider, "Morgan Stanley says demand for U.S. cotton is decreasing because of higher than expected Indian exports and weak demand from emerging market textile manufacturers". If demand for U.S.-based cotton continues to slow, the commodity may in fact begin to text the $70/contract level or even drop as low as $67.50/contract. In an effort to strengthen my argument that a bear market may be upon us, The Cotton Market News notes that, "China's harvested area is expected to decline 9 percent from a year ago to 5.0 million hectares in 2012/13" and as a result reserves may very well be tapped.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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