Time To Cotton On!
Cotton's collapse is particularly important as an unprecedented bubble in global cotton prices between July 2010 and March 2011, which saw prices treble on a mix of supply and speculative pressures, has been instrumental in pushing up clothing inflation across the globe over the last year. We estimate that clothing inflation is running at, or close to, record highs in China, the US and the euro zone. Cotton's collapse, which has seen prices drop around 2/3rds from their March 2011 peak, should therefore ensure that clothing inflation falls back rapidly over the next 6-12 months. And demand factors, proxied by Chinese narrow money growth, suggest little scope for any near-term recovery in cotton prices.
Clothing inflation appears particularly important in China given its estimated weight of around 8% in headline CPI which is roughly double the regional average according to our estimates. Econometric estimates suggest that CPI clothing inflation could fall by 2-3% points over the next 6-9 months, crimping overall CPI inflation by c.¼ other things equal. Downside risks to inflation from cotton, not to mention oil, mean that policy ‘space' in China may therefore be greater than typically assumed. Clothing inflation also looks set to retreat in both the US and the euro-zone, also increasing policy ‘space' for both the Federal Reserve and the European Central Bank.
Eoin Treacy's view Cotton continues to extend its decline but is becoming increasingly oversold in the short term. While potential for a bounce has increased, a sustained move above 85¢ would be required to question medium-term downward potential.
On May 11th I posted a number of charts for clothing companies which had performed impressively as cotton prices deteriorated and which were due a reversion towards the mean. This is currently underway but there are a number of others that have returned to their respective 200-day MAs.
US listed PVH Corp, Macys, Under Armour, Limited Brands, Ascena, Zumiez and Spanish listed Inditex have all returned to test their respective 200-day MAs and will need to find support in the current area if their medium-term uptrends are to remain consistent.