The cotton industry may have been placed on course for a 2008-style wave of collapses by the jump in futures prices of 30% in two weeks, on talk of demand to fill a huge US order, a leading analyst warned.
New York's spot July contract on Tuesday locked up the - expanded - exchange limit of 5.0 cents a pound, taking its price to 87.98 cents a pound.
The gain extended a sharp price rebound from two-year lows reached earlier in the month, a revival fuelled by short-covering supercharged by news last week that China had bought 744,000 running bales of US cotton for delivery in 2011-12.
That implies shipment by the end of next month, and a huge challenge in obtaining supplies for the US merchant said to be at the centre of the order.
"The shipper has to get hold of an astronomical amount of cotton within specification by July 31," Louisiana-based analyst Mike Stevens said.
Keith Brown at Georgia based brokerage Keith Brown & Co said: "Talk is that a major US merchant is paying a premium over July futures for cash cotton" to fulfil the contract.
'If you are hedged, you are dead'
However, the problem for holders of cotton is that, even as futures have soared, physical prices have lagged, rising by less than 8% over the past two weeks, including a 0.8% increase to 84.00 cents a pound on Tuesday.
That means holders of cotton hedging their inventories having to pay large increases in margins on futures contracts, against physical stocks which have increased only modestly in value.
"If you are hedged, you are dead," Mr Stevens told Agrimoney.com.
"It is similar to 2008," when the same type of dislocation prompted merchants Weil Brothers to quit the trade and Paul Reinhart to file for bankruptcy.
Reinhart said in 2008 ahead of its collapse that an "unexpected, historic run-up" in cotton had led to margin calls on futures contracts, stripping the group of "virtually all available cash".
The warning comes as merchants are still recovering from cotton volatility last year which prompted a spate of contract defaults – from producers as prices ran up to a record top and, as values subsequently collapsed, from mills attempting to escape purchases agreed near the peak.
The crisis dragged Glencore's agriculture division into the red, and besides denting profits at Noble Group, and contributing to its first quarterly loss in a decade.
Multi-commodities houses "might well say 'why are we in this cotton business? Why are we giving ourselves this headache'," Mr Stevens said.
"One of the troubles is that you just could not see this thing coming."
The extent of the rise in futures prices is also seen as a symptom of the historically-high short positions which traders held going into the rally, and the imminent expiry of the July lot, which leaves little room for manoeuvre before the contract gains liabilities against physical cotton.
The extent of the Chinese order which needs to be filled "opens the door" for delivering merchants "to take delivery of all or any cotton against the July contract", Mr Stevens said.
Even so, it was "doubtful" that the order could be shipped in time, potentially meaning a roll of orders to new crop, or cancellation, either of which was likely to prompt a significant pull back in prices.
Mr Brown said that, when the order was fulfilled, pries would "splutter like a deflating balloon".