Cornerstone’s brief report on the trip, written in February of 2008:
- Although the United States economy is likely in a consumer recession, we remain in the midst of a longer-term, continuing global expansion. Several million people are joining the emerging world as their economic standing improves through expanding globalism. The early stages of this cycle have been marked by significant increases in the price for natural resources, and this has been reflected through prices for copper, lumber, petroleum, etc. This phase is associated with the building of the infrastructure needed to deliver products to the rest of the world. In the same manner that commodities similarly boomed during the Industrial Revolution, they are experiencing rapid increases in price as China (and others) become the factory to the world. The next phase, which we have likely just begun, is the emergence of members of these societies into a global middle class. This is marked by the ability to consume beyond merely what is needed for sustenance.
- Some of the purchases associated with this increased ability to spend include foodstuffs, as people demand more and better food (moving beyond rice and grains into meats, fruits, vegetables and dairy). Also associated with this is the desire for better textiles, from bedsheets to towels to denim or undergarments. The most likely beneficiary of this new desire would be cotton. Yet, farmers in much of the world could be changing from this crop at just the wrong time after years of dreadful markets.
- Our report on King Cotton reviewed the following:
-The factors that first interested us in this theme.
-Details of US production, and why our farmers are changing to other crops.
-Potential global demand and international competition.
-Ideas to capitalize on this investment idea beyond futures (available only to clients).
Why did we become interested in this idea?
- After investing in economies heavily dependent upon natural resources in late 2003 and early 2004, it seems to us that many of those investment ideas have run prices beyond fair value at this point. While we continue to believe our theme of global economic expansion, it seems that investing in Canada or some petroleum firm on Canadian exchanges is an idea that has passed for the time being. Yet, the trend towards globalism shows few signs of abating.
- While other commodity prices have increased dramatically in response to global demand (for copper, lead, platinum, etc.) and some food staples have begun to participate, cotton has not experienced such a boom. As a matter of fact, there has been minimal price movement in quite some time and certainly no absolute increase in price.
- As a matter of fact, during the course of research for our trip, we visited the National Cotton Museum in Memphis. In the 1870s, the facility was a bustling cotton exchange, and it continued to operate through the early 1970s. It is now a museum. Throughout its existence, its function was to serve as a facility allowing cotton brokers to grade cotton and allowing these brokers to serve as intermediaries between farmers and mills. The exchange was established in Memphis since a large percent of the US cotton market at that time was grown within 200 miles. While more developed exchanges, financial innovation, technological advances and standardized grading are all in part to blame for the transition from bustling exchange to museum, it is certainly interesting to mention anecdotally.
- To supplement the concept of the diminished role of cotton within the community, also consider the headquarters of the National Cotton Council of America. When we visited the building, it was definitely showing its age. During our conversation there, we learned the facility was 50 years old, but they were soon to be moving. The Council presently has 36,000 square feet but only needs 18,000. Where they formerly employed 100 people, now they have a staff of 40. While these illustrations are not worthy to build an investment thesis upon, they are the types of things that contrarian investors really appreciate hearing before considering an investment idea.
- Being located in the Southeastern United States offers some intangible benefits for Cornerstone as investment managers, one of which is that we do not get caught in the groupthink that often pervades Wall Street. This time, though, the advantage is associated with having an understanding of the crop of cotton and knowing the resources to access those who can help explain the details of the cotton cycle. We had been reading articles about gins shutting down and watching drought conditions in our area amplify when we began to ask some questions about the crop itself. While the drought may not have the impact we initially thought it might, what we did learn was that there were a number of farmers intending to change crops. Given that we think global demand may begin to push higher for reasons mentioned above, this would be changing from production of the commodity at precisely the wrong time.