Cotton Futures Dynamics: Structural Change, Index Traders and the Returns to Storage

The commodity bull cycle of 2006-2008 and subsequent dramatic price decline have been asource of hardship for traditional commodity market participants such as producers andmerchant/shippers. The usefulness of futures markets has been called into question, especiallygiven that some market movements did not appear to be justified by economic fundamentals. Anemerging research literature examines the possible influence of futures traders, and particularlythe non-traditional Index Traders, on the well-functioning of futures markets and underlyingcommodity markets. Cotton is a relatively under-studied commodity that is of particularimportance for producers in the South and Southwest. To this end, this paper asks the followingquestions: (1) What role have (primarily long-only) Index Traders played, if we simultaneouslyaccount for important ongoing changes in cotton economic fundamentals? (2) Have seasonaland long-run patterns of convenience yield and price volatility changed during or since thecommodity bull cycle? (3) How well do the data support a theory of storage model using theconcept of convenience yield, and has the relationship changed with the commodity bull cycle?The results presented in this paper suggest that traditional, well-established economicrelationships for cotton futures markets clearly have been disrupted during the period 2006-2009. However, we find no direct evidence to support the claim that Index Traders areresponsible for changes in prices or volatility.