India's Bale Out

For the second time in as many years, India has caught the outside world with its hand in the cookie jar.

India, the second-largest producer of cotton in the world behind the U.S., announced on Monday an immediate ban on cotton exports. It cited that it had already exported 8.5 million bales of cotton in its fiscal year that ends in March -- far beyond the export estimate of 8.4 million bales that the Indian government had been targeting.

In recent months, the rising price of cotton has slowly eroded the competitive pricing advantage Indian textile manufacturers had held over Bangladesh and China. Keeping all cotton production domestic, at least for the time being, should restore India's textile pricing advantage over other nearby countries. It should also be noted that total projected output for the year has also fallen from a previous expectation of 35.6 million bales to 34.5 million bales.

If this sounds eerily familiar, as I alluded to before, it should.

In December 2010, India did the exact same thing -- cut off cotton exports. The last time this happened, the retail market was taken for a wild ride that would make even the most volatility-loving traders green with envy. Cotton prices spiked to $2.27 per pound, and trading firms that made a market in trading cotton lost their shirts. Swiss-based Glencore logged a $330 million loss last year from cotton volatility alone.

The $64,000 question then becomes: Are we headed toward cotton bubble round two?

Maybe. Let me explain further.

On the bright side, cotton demand is now considerably less robust in Europe and the U.S. than it was in 2010, which should allay some of the potential supply shortfall. In addition, consumers are turning to less traditional forms of fiber. Polyester and synthetic fibers have been gaining popularity in recent years and are thwarting an all-out upward march in cotton prices.

Then again, the mind of a trader is a scary place. Most traders vividly remember what happened when India cut exports in 2010 and watched prices more than double. Also, China currently accounts for about 80% of India's cotton exports and, the last time I checked, China was the most relevant country on a global perspective when it comes to maintaining macroeconomic stability. Even with a lowered GDP forecast calling for 7.5% growth, China is carrying a myriad of industrial sectors around the world on its shoulders. If China doesn't get enough cotton to meet its demands, that could ultimately wind up wreaking havoc from a trickle-down perspective.

My overall opinion is that we will indeed see modest gains in cotton prices -- nothing on the order that we saw last year when cotton prices shot aimlessly higher, but a modest 20% to 30% rise seems plausible. U.S. companies which could find themselves most at risk of rising cotton prices are those which rely heavily on denim-based products.

Liz Claiborne's (NYSE: LIZ  ) Lucky jeans line and True Religion Apparel's (Nasdaq: TRLG  ) denim products could feel a pinch, but these are generally high-price-point items that could easily be raised even further in order to pass along rising input costs.

The real pain could be felt in the mid-range price points that incorporate a smaller amount of cotton into their denim. VF (NYSE: VFC  ) , which owns the Lee and Wrangler lines of jeans, and J.C. Penney (NYSE: JCP  ) , which owns the self-labeled Arizona jeans, could find that margins become smaller as they attempt to stick to psychologically important price levels.

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Let's hope for everyone's sake that India comes to its senses and lifts the cotton export ban soon. In the meantime I'll watch and wait patiently to see if cotton prices again shoot for the moon.

What's your take on India's move to ban cotton exports? Share your thoughts in the comments section below.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He admits to being the purveyor of some terrible puns and would like to assure you no one lost their shirt in the writing of this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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