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Annual Preview: Speculation Is Too Risky for Textile Manufacturers

Avatar for Jim.Robinson By Jim.Robinson|January 5, 2012

By Kamil Saigol
Kahinoor Textile Mills

The cotton market continues to surprise participants with its ability to defy expectations. Erratic weather patterns, the influence of hedge funds and other financial traders, government intervention and a rapidly growing population have all conspired to create astonishing volatility, with both record highs and crashing lows within the space of a single season.

Not only does this volatility exacerbate the problems faced by participants in the cotton textile chain, but in a broader view serves to drive consumers away from cotton products due to high and unpredictable prices. Mitigating these issues requires a return to conservative, sustainable business practice with a focus on the sanctity of contracts.

Perhaps more than any other party, spinners and manufacturers have suffered greatly as a result of the volatility of cotton. Several spinners have been forced to close or restructure as a result of speculative raw materials purchases. However, manufacturers are doubly pressured: not only are they exposed directly to the vagaries of the cotton market through their raw material requirements, but they must also face uncertain contracts with respect to the sales of their products. Many are now convinced that speculative purchases are too risky.

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Avatar for Anonymous Anonymous says:
May 5, 2012 at 2:53 am

Dear Kamil;

You make a valid point about returning to conservative business practices, but isn’t a part of being competitive is to adapt to market changes? High prices and volatility will remain a dominant part of the cotton trade in years to come, to think otherwise would be merely nostalgic. Perhaps, spinning mills should also use effective hedging techniques like producers and cotton traders do to reduce the effect volatile prices have on their bottom line.

Looking forward to reading the rest of your article in the Annual issue of Cotton International.

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Avatar for Anonymous Anonymous says:
May 5, 2012 at 2:53 am

Sir,

I agree with you, in that hedging is an aspect of conservatism that seeks to mitigate the effects of volatility on cotton purchase. In my mind, the issue is not whether or not mills should practice hedging; rather it is that the ability of textile producers to hedge effectively is often limited.

Hedging cotton is only effective when the sales of an intermediate or finished good from purchased cotton are guaranteed by a strong, enforceable contract. The higher one moves up the textile production chain, the ability to enforce contracts, or to penalize parties for failing to adhere to contracts, is greatly reduced. For example, the purchase and sale of cotton is governed by a set of standardized rules that are enforceable internationally through administrative or governing bodies such as the ICA. However, fewer such rules exist when buying or selling yarn and even fewer when trading fabric or finished goods. Unfortunately, the addition of value at each stage also makes it easier for a buyer of a good to find a pretense to renege on a contract; quality, delivery, and other parameters are not standardized and can thus be used as an excuse resulting in failure to adhere to a contract. The lack of internationally-accepted governing body further exacerbates the issue. Thus, a mill can hedge its purchases, but if it cannot sell the products it makes using those purchases, the mill is stuck with raw cotton or finished product regardless of whether or not it has hedged.

Another issue is that many mills, especially in regions such as Pakistan, simply do not have the education or experience to begin hedging effectively. There is a real need to educate purchasers working for mills in both the theory and the application of hedging commodities so that they may approach the activity systematically; ad-hoc approaches often increase risk exposure, thus defeating the purpose of hedging.

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