Commodities are screaming, demand pressure from the rising global middle class, foolish government ethanol mandates, and to a lesser extent the falling U.S. dollar has added to the tail wind pushing commodities higher.

In "Filling Up on Natural Gas" I identified natural gas as being undervalued and ready to move higher. Since then natural gas has climbed 32-percent and looks poised to hit my target of $15 per million British thermal units.

Much of the same fundamental bullish outlook that brought natural gas to my attention as a screaming buy has led me to another undervalued and often overlooked commodity that looks poised to move higher -- cotton.

The Ethanol Effect

Ethanol mandates from countries like the United States, Australia, Canada, and Brazil, have resulted in tight global supplies of not only corn and soy that is used to create ethanol, but for less profitable crops that farmers switch out of to produce it.

In order to satisfy ethanol demand farmers planted the largest corn crop since 1944 last year, shifting acres that would traditionally be used for wheat and soybean into additional acres of corn. This acreage shift combined with drought conditions in Australia and other growing regions, resulted in record low supplies of wheat and soybeans sending prices to stratospheric levels.

In order to satisfy the shrinking supplies of grains, farmers are turning their traditional cotton acreage into much more profitable soybeans, wheat, and corn. I expect the switch out of cotton into feed grains will accelerate causing the USDA to lower yield estimates driving prices higher.

Shrinking U.S. Crop

While some 80 countries from around the globe produce cotton, the United States, China, and India together are responsible for over half of the world's cotton production. The United States is the leading exporter, accounting for over one third of global trade in raw cotton.

This year, cotton acreage nationwide dropped 28-percent, hitting an 18-year low of 11.1 million acres, according to the United states Department of Agriculture. Acreage dropped by about 22-percent in Texas, the national leader, and by nearly 20-percent in California.

Production is declining in many other countries as well, with Turkey's production falling 9-percent and an 18-percent decline in the African Franc Zone. Global cotton production for 2008/09 is forecasted to decline by 2-percent from the previous season to 118 million bales.

Increasing Cotton Demand

Growth of the middle class in the BRIC (Brazil, Russia, India, and China) countries is increasing demand for textiles used to produce clothing, furniture, and other consumer goods as well.

World cotton consumption is forecasted to increase 2.1-percent in 2008/09 to 127 million bales, resulting in a decline of global supplies by 12-percent to 10.9 million tons, the lowest in four seasons.

Government Subsidies Subsiding?

Brazil, supported by African countries, took the United States to the World Trade Organization in 2003 over farm subsidies. The WTO ruled in 2004 that the subsidies were illegal, and the U.S. took it to the long appeal process.

The United States lost the appeal on June 2. With the WTO ruling that Brazil will be allowed to seek approval for more than $1bn a year in sanctions on imports of goods and services from the US.

The subsidies of 2 to 4 billion a year provided through the Farm Bill were designed to protect small farmers from a collapsing market during the Great Depression. Today, a quarter of all subsidies go to the top 1-percent of producers.

Without this artificial floor, farmer's incentives to plant cotton instead of more profitable feed grains will be erased, making it very likely that significantly more cotton acres will bear other crops.

Now is the Time?

Supply and demand fundaments in the long run determines price, but the market can stay irrational longer than you can stay liquid. With this in mind timing and risk management are the keys to success in these volatile times.

As you can see in the chart below, cotton climbed 35-percent in the last 2-weeks of February. This sparked an investigation by the CFTC into whether the price run-up was due to market manipulation. Subpoenas went out and traders stepped to the sidelines sending cotton 40-percent lower in the past 3-monthes.

Shrinking U.S. cotton production, rising demand, with ending stocks projected at a 4-year low, not to mention a recent 40-percent pull-back makes cotton an appealing proposition going forward.

Trading cotton futures or options on futures is perhaps the most direct way of participating in cotton. If you would like further information or strategies to get exposure to cotton or any other commodity, feel free to contact me Devin Brady at dbrady@axisfutures.com or (800)601-3489.