By Andrew Woods, ICS | Source: WI, AWEX, RBA, ICS
The floating exchange rate is designed to help shield the Australian economy from the swings and roundabouts of international economic cycles. How the exchange rate and commodity prices interact varies through time. This article takes a brief look at the interaction between wool prices and the exchange rate during the past two decades.
Figure 1 shows annual averages for the 21 MPG (in Australian dollar terms) and the Australian / US dollar exchange from 1992 through to the current season (2014-2015). A brief look at figure 1 reveals periods when the 21 MPG moves in the opposite direction of the exchange rate (as in the 2000-2004 period) and periods when they moved closely together (2005 through to 2011).
Figure 2 shows analysis of the correlation of movements in the wool price and exchange rate by season. The correlation can vary from +1 (in which case the two series would move in lockstep with each other) to -1 (in which case the two series would move in perfect reaction to each other – in opposite directions). If the correlation is close to zero, then there is no relationship between the two series.
The period of strong positive correlation between 2005 and 2011 stands out, with the annual correlation often between 0.6 and 0.8. During the 1992 to 2004 period, the correlation swings from strongly positive to strongly negative a number of times. This tells us that the relationship between the 21 MPG and the key A$/US$ exchange rate is volatile, with no consistent structure.
Does the relationship between the 21 MPG and the exchange rate hold for other categories of wool? For merino combing wool the answer is yes. However for the crossbred categories the story is a different one.
Figure 3 shows the annual correlation between the 30 MPG and the A$/US$ exchange rate. The general rule for this relationship is for it to be strongly negative, with occasional periods when the correlation weakens. Why the difference?
Australia is the major producer of merino combing wool so movements in our market are the benchmark for the industry, and these prices are denominated in Australian dollars. What we call crossbred wool (basically 26 to 32 micron) is produced around the world and Australia is merely one of a range of producers. In this case, the market price is set internationally, between a range of suppliers. As such, movements in our crossbred market alters our basis to the international market rather than the international crossbred market itself.
The relationship between Australian wool prices and the A$/US$ exchange rate is highly variable for merino combing (and carding) prices but more consistently negative for crossbred wool. The correlation between price movements so far this season and the exchange rate have been strongly negative, with the falling exchange rate helping to shore up merino combing prices and pushing crossbred prices to very high levels. While the lower dollar is good for wool prices at present, history tells us that the relationship between wool prices and the exchange rate will change.
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