Spinning cotton

Cotton is the latest commodity to feel the inflationary effect of government incentives designed to encourage US farmers to grow more corn for ethanol, a fuel additive. As land is turned over to corn, there is less acreage available for other crops. That has already fuelled a boom in wheat prices. In the 2006/07 planting season, just under 11m acres of cotton were planted - down 29 per cent on the previous year. A further drop is expected next year. And no wonder: the cotton price has risen only 17 per cent this year, compared with 35 per cent for soybeans and 67 per cent for wheat. As cotton is also more difficult to grow, switching into wheat or beans is a bit of a no-brainer for most farmers.

With global inventories of cotton shrinking, there is talk of prices hitting $1 per pound, a level last seen in 1995. That is still far below the $12 level, in real terms, reached during the US Civil War. But it would mean a 54 per cent gain on the current price of 65 cents.

As with many other commodities, the actual amount of cotton that is physically traded is low. At its current price, the implied size of the annual market is $36bn, making it comparable to nickel, which tends to be volatile and has been subject to a short squeeze in the past year. And while acreage is declining in the US, high prices will encourage other producers - particularly in China, the world's biggest importer of the stuff - to grow more, causing a sharp correction. Only those investors with impeccable timing should buy direct exposure to cotton. Others risk losing their shirts.