Last Friday cotton futures in New York closed very close to $2/pound – the March 2011 contract traded as high as $1.9455 but ended the day at $1.8997. This represented a staggering 13.17% rise in the week. At the start of February when we speculated that cotton futures could hit $2, there was a sharp intake of breath in some quarters – surely not? Now it’s inevitable – and talk in the market is of the May or July contracts getting to $3 or even $5 a pound.

That seems incredible – but we are living through incredible times. Cotton has been dirt-cheap for years, and the price signal that gave out to farmers was simple – plant something other than cotton. When cotton fell to below 40 cents in the darkest days of the recession, in November 2008, for the first time since mid-June 2001, the price signal – and more important, the wider macro-economic signal to US farmers – was unbearably bleak. Everyone argued that it would take years, not months, for demand to recover and prices to clamber back to around 75 cents. At that time we went against that consensus and argued that the powerful economic growth in China and other emerging markets would pull the price back up. In November 2008 we forecast that by November 2009 the price would be much stronger, around 80 cents. We got the trend right – by 19 November 2009 the first position contract was around 75 cents/pound.

So what’s next for cotton? The $5/pound talk is not insane. Sure, there is a daily limit on ICE Futures US of 7 cents, but there are more than enough trading days between now and the end of May to get to that point by mid-year. Most of the northern hemisphere crop has now been harvested, and weekly exports from the US, the third-biggest producer, are brisk. More than 95% of the 2010-2011 US crop has been sold. Demand destruction – that age-old threat supposedly created by high international prices – is not happening at almost $2 and there is no reason to think it would at $3. India, the second biggest producer, is deeply reluctant to let more exports go, above the 5.5 million bales already sanctioned, especially at these high prices. China, the biggest producer, is struggling with drought. US farmers will no doubt plant much more cotton this year than last. But that won’t help in the short-term. As the price goes up, more speculative money will join the party, pushing up prices even further. But make no mistake, this is a rally very well underpinned by the fundamentals of supply and demand.