Here’s something that will get your undies in a bunch.  It turns out the world’s greatest fabric, cotton, is in the middle of some rather heated lawsuits.  And it won’t take you long to figure out who’s behind a lot of the nonsense.

For those of you who aren’t familiar with how it works, cotton is a commodity that is traded just like oil and gold.  There is a party who agrees to buy the cotton at a certain price and there is a counter-party who agrees to sell the cotton at a certain price.  In between is a middle-man who is trying to coordinate everything and satisfy both parties.  Sounds as easy as walking into Macy’s and buying some flannel pajamas.

But wait just a cotton-picking minute, (sorry, I couldn’t resist) it turns out there’s a large list of participants who’ve been stiffing each other on both sides of the trade. Worse yet, nobody has any recourse to satisfy the broken promises.  Last year, there was more than a 300% increase in the amount of complaints filed to the International Cotton Association, or ICA.  

Typically, a farmer will break the contract because cotton prices have shot up from the time he agreed to sell at a price, or a textile mill will renege because prices have dropped since the agreed upon price.  And folks, if you think we’re talking about cotton being grown in the South and shipped to mills in the North, those days are long past.  Today, most textile factories are in countries like China and Vietnam.  While this means they can produce the goods very inexpensively, it also means there is very little enforcement of arbitration rulings.  So companies can back out of agreed upon contracts and then not pay the penalties imposed to them for such foul behavior.

So where does this leave you?  Well, first of all, when a middle-man gets stuck with a broken contract, he’s forced to fulfill the promise he made to the counter-party.  That may sound good, but it if you think he’s just going to eat that cost, think again.  He’s going to pass that cost along to the next buyer as quickly as he can, and of course, that will eventually trickle down to you and me when we buy our socks and tee shirts.  Also, I sometimes get people in my office who want to dabble in futures or commodity markets.  Folks, this is dangerous territory.  The description I just laid out is for one commodity, but don’t think cotton is alone in dealing with this type of behavior.  How is a typical retail investor supposed to navigate these situations?  Not only that, but what effect does one big, blown up contract have on a thinly traded ETF?  Many people are curious how an ETF can run counter to the market it represents.  It’s because many people don’t understand the instruments that underwrite an ETF.  This is just one of the many ways over-zealous, under-informed investors can find themselves in a lot of trouble.