6. The Cotton Exchanges
“Spot” and “Futures”
The Great Markets
Cotton trading falls roughly into two categories: trading in cotton for immediate delivery, or spot cotton; and buying or selling for delivery at some future time. Purchases or sales of spot cotton mean that cotton actually will be delivered from vendor to purchaser, but, as we shall see, trading in futures does not necessarily mean that the contract will be fulfilled by delivery. The great cotton markets are New York, Liverpool, New Orleans, Bremen, and Havre. Of these New York is almost entirely a futures market, while New Orleans is chiefly a spot market. Liverpool, Bremen, and Havre trade in both spot and futures, but Liverpool is the European centre for trading in future contracts.
The New York Cotton Exchange
Only about 2% of the annual crop is sold spot in New York, and yet it is the prices on the New York Cotton Exchange which govern very largely the price paid to the grower in the South by the various buyers. The New York Exchange is the barometer of the American, and to a large extent, of the world’s cotton trade, because its mechanism works out the equilibrium between demand and supply; and as this mechanism consists chiefly of the trading device called the “Hedge”, we shall digress for a moment to consider its operation.
The “Hedge”
We might say that hedging is an insurance against fluctuations in cotton prices by purchase or sale of future contracts for cotton against sale or purchase made for actual delivery. It consists of nothing more than of neutralizing the gain or loss which will result from existing delivery contracts if the price rises or falls before delivery date, by creating an off-setting loss or gain.
As Used by the Merchant
Assume, for instance, that a merchant makes a contract with a mill in July for 100 bales October delivery. He sells at the current price of let us say 30 cents per pound plus his overhead and profit. In due course he will obtain his cotton from the South, but in the meantime he covers, or hedges his contract by buying 100 bales of October futures on the Exchange. If he has to pay the grower 31 cents for the cotton which he has sold to the mill for 30 cents, he will on the other hand, be able to sell his future contract which he bought at 30 cents for 31 cents, so that the loss on one is neutralized by the gain on the other. Vice versa, he will lose whatever extra profit he might have made from a falling price.
By the Manufacturer
In the same way a manufacturer may buy futures against orders he has accepted for goods, based on the price he expects to pay for his cotton. Or he may sell futures to protect himself on cotton he has bought but has not yet covered by cloth contracts. Hedging by manufacturers, however, particularly in the North, is not a common practice, because the cloth market is not elastic enough to follow accurately in the wake of cotton prices, and also because the mill treasurer rarely wants to hedge cotton in his warehouse, preferring to rely on his own judgment in matters of purchase.
By the Grower
Occasionally a grower may find it to his advantage to hedge his crop. If, for example, he is satisfied in August that the present price for December is likely to be higher than he will obtain later, he may sell December futures for a conservative percentage of his crop, thereby guaranteeing himself against a drop.
Speculation
By far the greatest part of the future trading, however, is done by merchants, because they are actually engaged in the business of selling cotton which they have not yet acquired or of carrying cotton for which they have no contracts. Speculation, of course, enters into the dealings on the exchanges as an important economic factor, in normal times tending to stabilize by discounting future trends, but in periods of extraordinary demand or supply frequently causing violent fluctuations in prices. At such times there is always a good deal of agitation for preventive legislation, but it is unlikely that dealing in futures will ever be prohibited by law. The present regulations of the large exchanges eliminate abuse as far as possible, and the futures markets are really a factor of safety for the entire industry.
The Dissemination of Quotations
All the large merchants, as we have seen, have branch offices in the South, and all these offices have wire connections with the chief markets. On the basis of the Liverpool quotations and the New York opening prices the head offices will send out to their branches and representatives their daily limits, above which they are instructed not to buy. Inasmuch as most of the small growers are dependent for their news of the markets upon the buyers, they are at somewhat of a disadvantage, but the keenness of competition prevents their exploitation by unscrupulous buyers.
New York Cotton Contract
A contract on the New York Cotton Exchange calling for the delivery of 100 bales specifies Middling grade, but the seller may deliver any grades which are tenderable by the Exchange regulations. These grades are from Strict Low Middling to Middling Fair, but if tinged, not below Middling Tinged. Stains are not tenderable. The grades are determined and settlement made on the basis of so many points on or off Middling, which, as we have seen, is the basis for all quotations.
Buying Season
It is evident that mills, which require certain even-running grades, could of course never buy their cotton on the Middling basis. For this reason, except in the few cases where they buy direct from the growers, mills purchase their requirements from dealers on the basis of samples. Selling to mills, as opposed to selling M/B, is known as selling on merit. Mills usually begin to buy in September and fill about 60% of their year’s requirements by January. Those manufacturers who use the high grades usually buy earliest because of the limited crop from which they must obtain their share. Cotton is ordinarily shipped soon after purchase and stored not by the merchant but at the mill. The recent growth of Southern warehouse companies, however, has caused mills to carry less cotton than formerly. Mills ordinarily pay for their cotton in three days.
We have now traced rapidly how the cotton is grown and marketed, and our next concern will be to follow what happens to it during the process of making it into goods. Deferring for the moment consideration of cotton export from the United States, we shall proceed in Chapter Two, to glance at the various aspects of Cotton Manufacture.