If you ever wondered about the impact on commodities of the massive injection of liquidity by central banks into financial markets following the 2008 crash, a good place to look would be the cotton price.
Cotton futures went ballistic as investors using cheap money bet on China's massive post-crash stimulus. The fibre more than tripled in value from early 2010 to its peak of 230 cents per pound in March, 2011, followed by a sudden collapse to $1, just above cotton's long-term trading range of 60-80 cents.
In order to protect its farmers from loss, the Chinese government then stockpiled cotton, buying up surplus fibre to create a huge mountain of cotton. It was a disastrous policy, as traders rushed to sell cotton into China's subsidized market. From 2011 to 2013 enough cotton bales were in storage, said the U.S. Department of Agriculture, to make three pairs of jeans for every person on the planet.
But last year, Beijing threw in the towel, abandoning the expensive price support mechanism in favour of direct payments to farmers. The result has been a sudden fall in China's cotton import demand, just as the U.S. cotton crop begins to recover from a period of drought. The price collapsed again and in January, the International Cotton Advisory Committee predicted a surplus of 1.7 million tons, with stocks representing 87 per cent of annual consumption. Officials in Australia, now a leading cotton producer, are reckoning that prices could fall to a nine-year low.
It's a serious blow to cotton farmers in developing countries and to make matters worse, the price of polyester is also under the gun due to a worldwide glut in PTA, the petrochemical raw material for the synthetic fibre. Cotton and polyester are substitute raw materials at the low end of the rag trade and manufacturers should enjoy a margin boost as yarn spinners force their suppliers to cut prices to the bone.
Analysts at ICIS, the chemical price reporter, reckon that the oversupply in cotton and PTA will continue, leading to more price declines and, they suggest, a possible deflationary shock on consumer economies. Unlike falling fuel prices, which have a "good" impact, being part of essential expenditure where lower prices leave spare cash to spend elsewhere, clothes are discretionary items where spending can be delayed. If cheaper cotton leads to a race to the bottom in frocks and frills, deflation could go to unwanted and unforeseen levels.
That's a risk, if wages fail to increase fast enough to inject a feel-good factor into consumer spending. From the perspective of commodity producers, such as Canada, the important signal is that governments may be finally seeing the folly of seeking to manage commodity markets. The Chinese government has finally begun to end its massive meddling in resource allocation. Whether it is repealing the one-child policy or the fixing of fuel prices, Beijing is beginning to see that a decision to shift from an export production economy to a consumer economy means allowing markets to work. Hence, the decision to roll back cotton purchases.
Likewise, America is beginning to see the folly of its ethanol mandate, a piece of socialist market rigging that would rival even Beijing's worst market meddling. The artificial demand for corn created by the need to inject ethanol into gasoline has provided massive support for corn prices which in turn have driven up the price of animal feed. Expensive feed has in turn driven up the price of cattle, pork and poultry. The expense and market distortion of the ethanol mandate is beginning to annoy even U.S. politicians from Midwest and Western states and the Environmental Protection Agency in 2013 proposed a drastic cut to ethanol support, starting a steady fall in the corn price. A proposal is now being tossed back and forth in the U.S. Senate and the U.S. is expecting record volumes of corn in storage. Any further sign that Congress is willing to cut back on ethanol production and we could see corn prices falling further. That in turn will lead to cheaper burgers and ribs.
Even the European Commission is seeing the market wisdom. Milk quotas, for decades a major plank of the Common Agricultural Policy – and a target for its critics – have officially ended. Someone in the commission noticed that a few European states had become very efficient dairy producers and were shutting themselves out of an expanding dairy market, notably China. So, big dairy farmers in the U.K., Denmark,Germany Ireland, France and Italy will be able to produce at maximum volume, creating new competition for New Zealand and Australia in supplying Asia.
Could it be that governments are losing their fear of basic commodities – the food and fuel that rule our lives – and are beginning to see the wisdom in letting markets govern capital allocation, investment and price. If that is the case, it will have big implications for Canada, a country that depends heavily on commodity exports but so often finds itself out on a limb as an isolated high-cost producer, too dependent on a single consumer.
We now know the commodity supercycle was a strange beast, a creature born of shifts in geopolitics and artificial stimulus. If the global political trend is less intervention, more transparent prices and lower prices, the prize will go to the most efficient, low-cost producer with the best access to the biggest markets. It will be a game for the few, not the many.
Carl Mortished is a Canadian financial journalist based in London.
Carl Mortished