Exchange tightens reins on rampaging cotton market

NEW YORK (Reuters) - The main U.S. cotton exchange acted on Thursday to curb speculation in an overheated cotton market that has seen prices soar to heights unseen since the U.S. Civil War.

Hoping to prevent a repeat of 2008, when a sharp rally followed by a steep plunge roiled the industry, ICE Futures U.S. approved a rule change. The new rule would require investors with more than 300 lots in the spot contract to prove they are adequately hedged going into delivery.

Separately, the U.S. Commodities and Futures Trading Commission, the country's commodities regulator, said it has approved an expansion of the daily trading limits in the cotton market.

Both developments deflated the market, analysts said.

Cotton prices jumped to a record high at $1.8122 per lb in early trade. But as the exchange mulled its move, investors launched a massive liquidation spree. Futures sank the 5 cent limit before ending 4.36 cents down at $1.7186 in volatile dealings.

The exchange announced the rule change after the market closed. It was designed to prevent a repeat of the wild market swing in 2008 that drove two cotton houses out of business, sparked a merger and spurred calls for the government to impose position limits in cotton and other commodity markets.

"It's the type of thing a responsible exchange should do," Mike Stevens, an independent cotton analyst in Louisiana, said in an interview.

Sharon Johnson, senior cotton analyst with commodities brokerage Penson Futures, said ICE is trying to ensure that "we're not going to let a squeeze in the March contract."

"It encouraged some of the selling in the market," said Stevens, adding the psychology of seeing the exchange and then the CFTC "getting involved" weighed on the market even though the government decision would not impact cotton speculation.

In 2010, cotton was the biggest gainer on the Reuters-Jefferies commodity index, rising 90 percent. In 2011, it has risen almost 30 percent before Thursday's tumble.

ICE said in a statement that "cotton market participants who expect to carry positions in excess of the spot month position limit, 300 contracts (or 30,000 480-lb bales), into the notice period would be required to file an exemption ... with the Market Surveillance Department."

"Any exemptions granted would be for a specified contract month only and should not be viewed as relief from the responsibilities all traders have to transact their business in a manner consistent with an orderly market," ICE said.

The rule would begin applying to the March spot month contract during its delivery period, and does not affect back months.

Open interest in the March contract stood at 83,662 lots as of February 2. Total cotton open interest as of that date amounted to 211,283 contracts.

The Financial Times on Thursday reported that ICE was "poised to make an unusual intervention" in cotton markets to cool surging prices which harm mills and merchants.

But cotton traders said the change was not unusual, noting that other agricultural markets on the exchange already have limits on the spot contract before delivery.

"This is about an exemption to the limit before delivery, not position limits," one person said, adding ICE was harmonizing the practice prevailing in other markets.

Investors would need to seek exemptions to the position limit rule by February 14, five business days before the March contract goes into delivery.

Another trader said that, on face value, the rule would not slap limits on investors who had the resources to hedge against an unforeseen turn in the market.

"If anything, it allows investors to exceed the limits on the spot contract going into delivery," this dealer said.

(Editing by David Gregorio; Editing by David Gregorio)