High Volatility in Cotton: Should You Buy or Sell?

The price of cotton is changing rapidly. What's the outlook for iPath DJ-UBS Cotton TR Sub-Idx, iPath Pure Beta Cotton, and Culp?

Jul 22, 2014 at 11:18AM

The cotton market has been experiencing unprecedented volatility. About two months ago, the U.S., the world's largest exporter, was under a serious drought threat, and stockpiles were expected to reach a two-decade low.

But fortunately, good rain levels in Texas -- the top growing region in the country -- encouraged vast planting action, and now the government expects inventories to reach a six-year high before the 2015 harvest. In fact, according to a report by Plexus Cotton, U.S. output might rise 32%, with the crop exceeding 17 million bales.

Is it a good time to invest in cotton-related assets?
Whenever there's volatility, it's a good time to step back and look at the big picture. Oftentimes the market overreacts, and that's exactly where opportunities arrive.

If you take a look at iPath Pure Beta Cotton (NYSEMKT:CTNN), its price rose steadily from November until the beginning of May, when it began a steep downward slide that continues today:

CTNN Chart

CTNN data by YCharts.

The reduction in U.S. supply estimates pushed prices up until new data confirmed that supply would increase, pushing prices down. As you can see, prices in this ETN move fast. This fund is directly linked to the Barclays Capital Cotton Pure Beta TR index, which reflects the returns that are potentially available through an unleveraged investment in the futures contracts in the cotton markets.

According to a Bloomberg survey of seven analysts, futures may drop 6.1% by year-end to their the lowest level since June 2012. So be careful, as such a drop would be directly reflected in the ETN's price.

The same goes for iPath DJ-UBS Cotton TR Sub-Idx (NYSEMKT:BAL), which provides exposure to the Dow Jones-UBS Cotton Subindex but essentially tracks cotton futures contracts as well. The correlation is extremely high.

An investable opportunity?
A drop in cotton prices is not bad news for everybody. Considering that it reduces a primary cost for fabric, companies like Culp (NYSE:CFI) could see their margins go up. Culp uses cotton fibers for the fabrics it manufactures for the upholstery and bedding industries.

Culp is among the largest producers of mattress fabrics and one of the largest marketers of upholstery fabrics for furniture in North America, measured by total sales -- so we're talking about a lot of fabric production. But don't get too excited. Despite the fact that Culp purchases yarn and unfinished fabrics that contain cotton from outside suppliers, the movements in cotton prices do not affect the company's business significantly.

Culp's material costs are much more sensitive to changes in prices for petrochemicals and the underlying price of oil. Most of the company's products hold a high percentage of synthetic fibers, which correlate to movements in prices for oil and petrochemical products. Due to the price stability in the oil markets during the past year, Culp's costs have not suffered major distortions.

And since demand responded quite well, this past fiscal year the company showed a 6.8% net sales growth to $287.2 million, making this the fifth consecutive year of overall annual sales growth. Its mattress fabrics segment sales grew 4.3%, showing a record figure of $160.7 million. This segment accounts 57.3% of total net sales, with upholstery comprising the rest. This past year Culp introduced Culp-Lava, a line of mattress covers that aims at the premium segments, which are showing the greater growth. This new venture relies on new production lines in a new dedicated manufacturing plant.

Final foolish takeaway
For now, everything indicates that supply will increase and cotton prices will continue to drop. As a result, we'll probably see a continuation of the correction in these two ETNs. But there is one unpredictable factor that could change this analysis: potential weather damage during the months from planting to harvest, affecting futures again.

On the demand side, a recent report from the Cotton Advisory Committee forecasts weak cotton consumption for this year. The report expects world production to exceed consumption in 2014 and 2015, projecting enough cotton inventory to cover consumption for nearly 11 months -- all the more reason to expect a continued slump in cotton prices.

The case for Culp is not highly related to cotton price variations and depends more on the oil markets and how well the company anticipates fashion trends. The company has been successful, and its sales continue to grow, which makes it an interesting diversification asset in case these ETNs do not behave as planned.

Warren Buffett: This new technology is a "real threat"
At the recent Berkshire Hathaway annual meeting, Warren Buffett admitted this emerging technology is threatening his biggest cash-cow. While Buffett shakes in his billionaire-boots, only a few investors are embracing this new market which experts say will be worth over $2 trillion. Find out how you can cash in on this technology before the crowd catches on, by jumping onto one company that could get you the biggest piece of the action. Click here to access a FREE investor alert on the company we're calling the "brains behind" the technology.

Louie Grint has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers