By Andrew Woods, ICS | Source: AWEX, World Bank, ICS
With wool prices for most categories trading at high levels by the standards of history, has the wool market become riskier in terms of price volatility? Has the decline in production and decrease in stocks led to a greater movement in price? This article takes a look at merino combing wool, Merino Cardings and cotton prices since the fall of the Reserve Price Scheme to answer this question.
There are various ways of calculating price volatility. For this article, we looked at the variation in prices across rolling 18-month periods (using the standard deviation in monthly prices), and expressed the variation as a percentage of the average price for these 18-month periods. Naturally, price volatility rises when the market makes large moves either up or down, and subsides when there is little market change.
Figure 1 shows the 21 MPG (in Australian dollar terms) from mid-1991 onwards along with the price volatility (which looks back 18 months). Price volatility has tended to peak around 25% (after the 1994 and 2002 price rises and the collapse of prices in 1998-1999).
The big rise in 2011 resulted in a rise in volatility, but not to the peak levels of the 1990s. Since 2011, the price volatility for the 21 MPG has subsided to low levels, reaching 5% in early 2015 before picking up slightly with the autumn rise in prices. From this perspective, price volatility in the 21 MPG is low and has been (except for the 2011 price spike) for the past six years or so.
Figure 2 shows a similar analysis to figure 1 for Merino Cardings, one of the boom categories in the apparel fibre markets. As the volatility measure is proportional to the price, it is comparable to the 21 MPG measure of volatility.
In the 1990s, the volatility of the merino carding indicator ranged up to 25%, as did the 21 MPG volatility. During the past decade it has spent a lot of time in the 10-15% range, slightly higher than the merino combing price (represented by the 21MPG) volatility. With the rise in price during the past year the volatility has risen to around 15%, high by the standards of the past decade but not extreme.
To provide some perspective on wool price volatility, figure 3 shows the same method of analysis for the Cotlook A Index (an index of cotton prices). The astounding price peak of 2011 stands out. This peak lifted the cotton price volatility from its range of 5% to 20% of the previous two decades, to extreme levels of 40%. However, with the subsidence of prices to low levels (weighed down by massive stocks) the price volatility has fallen to around 10% for the past couple of years. In the 20 years to 2011, cotton price volatility was similar in range to wool, although limited to maximums around 20% whereas wool peaked around 25%.
Has the lower supply of wool caused price volatility to increase? The evidence shows that wool price volatility has been low to normal in recent years (depending on the category). Where price volatility is used as a proxy for risk, this means that the risk in the wool market has been lower than that of the preceding 20 years. The price volatility in cotton has also fallen in recent years to “average” levels, with the massive stocks limiting the ability of cotton prices to rise, thereby reducing price volatility. It would be natural to assume that the lower supply of wool is helping to limit price falls, thereby reducing price volatility (same outcome as cotton but for the opposite reason). However price volatility has fallen for other commodities as well, so it appears to be a general pattern for apparel fibres and commodities rather than a pattern specific to wool. That implies price volatility in wool is dependent on external factors and history shows that price volatility varies. Low price volatility is unlikely to be a permanent feature of the wool market.
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