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THE $500 MILLION COTTON BUST I plan to tell you a true story about hubris, greed and a $500 million bet turned sour in the cotton market. Before we get to that story, I should point out (assuming you don’t already know) that the markets at times can be diabolical; the markets of late are no exception, particularly cotton. Cotton has been in a vicious downtrend this year. Last Friday, the near month collapsed to new contract lows, with the new crop December contract falling close to new lows despite a bullish crop report. December Cotton (Every 1-cent move equals plus or minus $500 per contract traded.) Source: Commodity.com The US Dept of Agriculture estimated Friday that, because of sharply decreased planted acreage, ending stocks for the 2007-08 season would plummet to 6.40 million bales, down sharply from this year’s 9.50 million bales. It also raised world usage to 127 million bales from the current 122 million, in large part because of Chinese demand. Acres planted will be nearly the lowest in three decades because competing crops such as corn are much more profitable to plant. When supplies are projected to fall sharply in an environment of increasing demand, it sounds like a recipe for a market opportunity. So why haven’t prices responded? Will they, and if so, when? We’ll come back to these questions, but first I want to turn to the story of Julian J. Hohenberg--the fallen king of cotton. Hohenberg Bros was a respected Memphis, Tenn.-based cotton trading firm, established in 1879 by Julian’s grandfather. Julian sold the firm to Cargill in 1975, and in 1985, he left Cargill to start his own firm. The Julian Co grew quickly as Julian hired traders at twice the industry salary and moved them into elegant offices in the Union Planters building. Long before Google, he pampered his employees with free catered lunches daily, but he demanded his employees be at his beck and call, regardless of the hour. He would fire employees one day, only to rehire them the next, and was known for his explosive tirades when things went wrong. Still, the firm grew dramatically; in four years, it became one the biggest players in the global cotton market (in large part because of the financial backing of Bankers Trust). In mid-1989, Julian got the idea that cotton (then trading around 60 cents to 65 cents a pound) was going to hit $1 a pound because of his poor crop projections. He sent out a very bullish newsletter in July, but for months prior, he instructed his traders to accumulate large quantities of cash cotton at whatever price it took to outbid his competitors. While he was accumulating this cash cotton (at times faster than he could store it), he was simultaneously "Texas hedging," or buying big numbers of cotton futures contracts and options with the margin money coming from Bankers Trust. The goal was to be the cotton king of the world and reap a massive profit. But the harvest came in better than expected, and $1 cotton turned into 50-cent cotton. Although the exact events leading to the company’s crash remain unclear, what is clear is Julian's belief that cotton prices would rebound. In November, when a fresh $70 million margin call came from Paine Webber, Bankers Trust told Julian it was unwilling to pony up any more money and the broker liquidated his holdings. The Julian Co declared bankruptcy in January 1990, and as the books were unraveled, it became clear Julian's cotton bet amounted to a $500 million loss. He even used his children’s $23 million trust in the failed effort to support his position, and his children joined more than 900 other creditors identified by the court-appointed trustee. The trustee said it appeared he used the company’s assets as his personal checkbook. Here’s is the irony of this story: He was ultimately proven right. Shortly after his brokers liquidated the company’s futures and options for nonpayment of margin, the cotton market started to head back up. By March 1990, it was back to his average purchase price, and by the summer (if he was still in the position), Julian would have been the king of cotton as prices rose to more than 75 cents a pound. Weekly Cotton 1989-90
Is there something to be learned from this story for today’s market? I believe so. First, nobody is bigger than the market. It doesn't matter how much money you have or if you are right in the long term; in the short term, money flows are the most-important fundamentals. Second, my basic approach of following the trend is, in the long run, the right way to play the markets. It's important to be aware of the fundamentals; it's most important to have the market trend moving your way before you fully commit. Today the fundamentals appear to be very bullish for the cotton market, but before I send out a new buy signal for my Futures Market Forecaster subscribers, I want to see the technical trend indicators turn back up. Stay tuned. Note some of the Hohenberg material was provided courtesy of The Atlanta Constitution archives.
George Kleinman is editor of Commodities Trends.
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