Transitioning From Trading Cotton To Yarn Is No Easy Task
August 22, 2013 When China recently shifted its emphasis from importing raw cotton to importing cotton yarn, it sent shockwaves through both industries.
To get a better understanding of the differences between trading raw cotton and cotton yarn, Cotton International spoke with Pakistan-based merchant Altaf Katchi, who has found success trading both materials for decades.
1 Can you provide a brief overview of the cotton yarn trade over the last few years? Did it experience the same type of volatility as raw cotton has since 2008? Would you say it has been easier to be on the yarn side, as a merchant, than it has been to trade raw cotton?
The cotton yarn trade in Pakistan has been doing well over the last few years due to an abundant supply of domestic raw cotton at lower-than-world-average cotton prices. The persistence of a satisfactory demand from the sizeable local downstream textile industry and a growing demand for Pakistani coarser and specialized-count yarn for export – particularly from China, due to the higher support price of raw cotton announced there – have also had a positive impact. Pakistan’s spinning industry continues to benefit from relatively low production costs (despite recent increases in energy prices), which gives the sector a global competitive advantage.
When international raw cotton prices soared to a record high of $2.20 in March 2011, and then collapsed to less than $1 by the end of year, spinning mills struggled due to a squeeze on their credit line margins by their banks, high inventory costs, and the cancellation or price adjustments of their yarn orders in the wake of the price swings. While cotton prices have been quite volatile during the last two years, yarn prices have been less so. After initially following the fall in cotton prices, yarn prices did stabilize quickly, helped in some part by the huge growth of sales to China.
As a result, due to the increase in difference between cotton and yarn prices, spinners have had enough margins to absorb this high volatility to some extent and still maintain a good level of profitability during the 2012/13 season.
For the merchant, I would say that despite the recent, unprecedented volatility, it is still easier to trade raw cotton as a commodity than cotton yarn as a finished byproduct, because they have entirely different business models.
2 From the merchant’s perspective, what are the most significant ways the trade of cotton and cotton yarn differ? In what ways are they alike?
The biggest differences are mainly in infrastructure, mode of operation, and the risk management portfolio.
The raw cotton trade is more structured, organized and systematic. The cotton yarn trade has an entirely different infrastructure that is suited to the sourcing and marketing of a complex and wide range of products, as well as a varied customer base.
Unlike raw cotton, the global yarn trade does not have accepted rules and practices such as standardized contracts, future markets and hedging mechanisms, arbitration clauses, or regulatory bodies like the International Cotton Assn. (ICA) and its defaulters list, which enforce strict adherence to the contractual obligations of the stakeholders. Sale contracts for cotton yarn are often canceled or renegotiated when there are any abnormal fluctuations in price, with no possibility of protection like that provided by ICA arbitrations. It is quite difficult for merchants to manage the risks of both technical and quality disputes in the yarn trade, while handling very large numbers of customers – both spinners and clothing manufacturers.
With raw cotton, there are generally fixed premiums and discounts for different qualities. However, in the case of yarns, through producing high-quality yarn of a specialized nature and using multiple fiber types, merchants can maintain high-level premiums even in bad times. This helps to cushion high volatility in market prices. Simple products like open-end yarns – 21s, 24s, 30s, and 40s, etc. – all are commodity yarns, and thus their prices generally move in accordance with cotton prices. Only in case of a yarn shortage would the price trends be different.
Trading yarn is similar in the sense that many raw cotton merchants already have good penetration in major markets such as China, India, Pakistan, and other countries in the Far East. Merchants can take long or short positions and keep buffer stocks of yarn at the transit ports and bonded warehouses of importing countries to facilitate fast, on-time deliveries to consumers. Merchants can use new techniques and the latest technologies to manage the risk of market fluctuation in yarn trade, just as they can in raw cotton.
3 With China’s recent emphasis on importing cotton yarn rather than raw fiber, do you expect current traders who only deal in raw cotton to enter the yarn market to expand their opportunities? Why, or why not?
I don’t expect current traders who only deal in raw cotton to enter the yarn business because it does not seem viable for them in view of tough competition due to the high number of mills all over the world, an entirely different marketing infrastructure, high risks, and the fact that there is no organization like the ICA that they can turn to in the event of a dispute.
4 What are the advantages and disadvantages of each type of trade?
Raw cotton trade’s main advantages are:
• its highly structured business system, and
• relatively low competition and low risk in cotton business (dispute settlement is governed by ICA rules).
Raw cotton trade’s disadvantages are:
• the trade volume is shrinking due to China’s diminishing imports, and
• profit margins are low.
The cotton yarn trade’s main advantages are:
• trade volumes have grown due to China’s growing emphasis on yarn imports,
• there is still high potential for growth due to new challenges every day in yarn as changing quality parameters and the latest techniques and expectations vary from customer to customer, and
• profit margins are better.
Disadvantages for yarn merchants include:
• additional quality control is needed, and
• professional sales teams will be required to manage the yarn trade, which can be a very challenging thing to establish.
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