It Was A Very Volatile Year: Cotton Reels, While Textiles Roils

Thursday, July 02, 2009

History may or may not find 2008 marked the end of a period of extravagance, but for sure history will show that it was a year of volatility. Whether we consider the meltdown in the global financial system or developments on the political front, 2008 was truly a year for the record books in terms of terrific highs and terrifying lows. On the one hand, we enjoyed the competition and pageantry of the Beijing Olympics, while on the other we witnessed the horror of the earthquake in Sichuan and the atrocity of the hotel attacks in Mumbai.

Because this year is characterized by such highs and lows, one word typifies 2008: volatility. The same hold true for cotton. Cotton, that basic of all commodities, found its supply, demand and market price buffeted from hither to yond – and why wouldn’t cotton be immune from the volatile times?

This past year has seen cotton prices soar and crash seemingly in line with broader events in world. In some cases, macro-economic and geo-political developments directly impacted the world of cotton and textiles, while in other cases the price of cotton seemed to take on a life of its own, irrespective of global events. Nevertheless, volatility is the order of the day. Shell-shocked traders struggled to keep up with daily fluctuations in prices not seen in years. I bet this year set a record for market limit-ups, not to mention market limit-downs.

So what’s the net result? Some of the long-time players in the merchandising of cotton left the scene, while we saw some truly profound changes in attitudes towards the purchasing of cotton.

I could write a book on this past year’s developments in the cotton industry and write pages about the effects of hedge funds on the trade or the competition brought about by other crops thanks to the boom in alternative energy. Yet suffice it to say that the cotton business has most directly been affected by strong shifts in demand by the global textile industry. In turn, this shift in demand – both in terms of quantity consumed and the quality and varieties used – has directly resulted in many observers scratching their heads wondering what else can possibly be added to the mix.

So let’s identify some of the changes we have seen take hold of the global industry in 2008 in terms of the major cotton producing and consuming regions of the world:

1. China
The Chinese textile industry in 2008 was buffeted by significant consolidation. This consolidation – forced by weakening demand in the export markets and stepped up competition from other suppliers – has resulted in significant swaths of the local industry being mothballed and an adjustment in the types of products typically produced by the remaining industry. Although China continues to have the leading textile industry in the world, its days as the unchallenged supplier of textiles to the world’s markets may be numbered.

At the same time, a growing domestic market has also affected the local textile industry and has helped to change the industry’s focus to include the tastes and preferences of the domestic consumers.

So how have these changes been manifested? China has altered its buying patterns for cotton. Yes, there is still a domestic program to support local farmers, but the mix of cotton imported has changed. Take a look at US exports – it’s mostly comprised of varieties like Texas FiberMax (that is, varieties with a staple length of 1-1/8” or more and are not Pima).

What’s so telling is that the mix of cotton consumed by Chinese mills is that the top end varieties, such as Pima, and the more moderate end of the business, traditional upland varieties, have lost market share to the FiberMax-type varieties. This may indicate an acceptance of the part of Chinese mills to pay for quality varieties at a fair price may trump poor quality varieties at a discounted price.

2. India
In 2008, the Indian textile industry suffered from overcapacity. There was talk that a consolidation in the local industry will inevitably have to take place if India is to remain competitive in textiles, but there was also talk the government may offer a US-styled bailout of the Indian textile industry in order to keep employment levels high. These conflicting signals continue to make an assessment of the Indian textile difficult to make.

But, despite these conflicting readings, it appears that the commodity side of the business continues to dominate Indian production. In the U.S. market, for example, as India rose to become a major supplier of textiles and apparel to the U.S. its average price offered in that market fell over the past five years while the product mix shifted from typically higher cost quality products such as shirts to lower costs commodity products such a jeans and woven pants.

In turn, while India’s increased its ranking in the U.S. market by rising from a rank of 12 in 2002 to a rank of seventh largest supplier by 2007, the product mix changed from the predominate ranked product of last year with India gaining a significant share of the U.S. market in trousers (jeans and twill pants), while losing market share in woven shirts and sweaters – products that often require higher quality yarns.

Yet, demand for Indian textiles and apparel has fallen in the US and EU, the major export markets for Indian producers. And Indian mills are feeling the pinch.

3. US
Mired in a deep recession, U.S. textile and apparel consumption is down. Concurrently, with the bulk of the U.S. market fed by imports, poor conditions have resulted in sharply lower levels of imports (down 4.5 percent through October). Leading indicators suggest that the U.S. is in for a severe downturn, continuing to suggest little chance for a rebound in the health of the economy in the first few months of 2009.

According to the Conference Board’s Index of Leading Economic Indicators (ILEI) fell again in the latest month – for the thirteenth time in the last fourteen months the gauge has not risen. Looking ahead, the composite of ten leading indicators are down more than in the 2001 recession and almost as much as in the 1990-1991 recession, providing yet more evidence that the current downturn is likely to be deeper than either of the last two.

It would not be unreasonable to see fourth quarter 2008 GDP estimates drop at the steepest rate since the 1990-91 recession, with the current downturn ultimately rivaling the 1981-82 contraction (one of the worst contractions since the Great Depression).

4. EU
Long at the top-end of the global textile supply chain, even the vaunted spinners of Italy have succumbed to the price pressures of competitors. Technology, long an advantage for many producers in Europe, has now become its own commodity with state-of-the-art equipment commonly found throughout the world. Without the advantages of technology, mills in Europe have been shuttered across the continent. Many have sought refuge in Eastern Europe and North Africa and have taken advantage of preferential trade agreements to help blunt their competitors from around the world.

As though the difficulties of the EU textile industry weren’t enough, the domestic market has sharply contracted as the effects of the global financial crisis reach into the European economy. Apparel retail sales – a bellwether of economic conditions in Europe -- have faltered as recession has tightened its grip on the spending habits of consumers.

Not surprisingly, consumer sentiment in Europe remains bearish, with consumer confidence falling to near-record lows.

5. Rest of the world
Overcapacity has plagued the global textile industry for years and 2008 was no exception. This problem of overcapacity manifested itself in recent years with sharp reductions in the industries of the US, EU and Japan – the developed countries. Now, however, it appears that developing countries will also face the brunt of declining demand for their products and hence reductions in the size of their overall industries.

Yet despite the difficult environment for manufacturers and exporters around the world, some suppliers have shown remarkable resiliency. For example, Vietnam, Bangladesh and Honduras are all enjoying an export boom of sorts even as China and India struggle to maintain their footing in the global markets. Whereas U.S. imports of apparel from China and India declined by 2.5 percent and 1.0 percent, respectively, imports from Vietnam soared by 22 percent, Honduras rose by 11.2 percent and Bangladesh by 5.0 percent.

The Future
So what does the future hold? Will 2008 be just a bad memory or will it stay around like a bad hangover? Will the volatility ease? If history is any indication, periods of commodity volatility is typically followed by periods of relative calm. Although traders may fret over day-to-day or even hour-to-hour fluctuations of a market, when it’s possible to catch one’s breath and look at the market a calming effect has always seemed to follow periods of instability. Remember earlier this decade when cotton prices fluctuated with the frequency of paint drying? Those days may return.

Yet, as a cautious forecaster, I have suggested that perhaps they may not. If China continues going through dramatic changes in its textile industry, then what will happen to its consumption of cotton? Will China fall into the same trap that ensnared others? It is interesting to plot China’s textile growth and then graph it opposite historical textile growth in the US. China’s textile industry soared while the U.S. industry contracted. But the same thing can be said with the original rise of the U.S. textile industry after World War II – it soared only to the detriment of the industry in Europe.

The U.S. textile industry is now just a shadow of its former self and now even resorts to handouts from the government. Here’s something that I never thought I would ever see: the U.S. textile industry receiving government assistance, the recently announced Economic Adjustment Assistance (EAA) Program, a USDA-sponsored designed to provide financial assistance to U.S. textile manufacturers that invest an equivalent amount of funds in capital improvements to their operations. Payments under the program are based on the amount of cotton (domestic or foreign) consumed by the textile manufacturer after August 1, 2008.

Of course, I never thought I would see the same in the financial markets or automakers for that matter, but it has happened. For me, a survivor of the US textile industry, this announcement was particularly bitter.

What killed the American textile industry? Arrogance, for one thing; resistance to change, for another. There was always a feeling in the industry that it could out produce mills in any other country in the world. The problem was that it ended up producing products no one wanted. Will China’s textile industry follow a similar path? If it does, what will that mean for producers of cotton?

So the volatility of 2008 has made its mark on the global cotton and textile business. Does that portend a change in things to come?

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