By Andrew Woods, ICS | Source: WI, AWEX, ICS
Cardings (short staple length) prices are often mentioned as a leading indicator for combing (longer staple length) wool prices in the wool market. Analysis of simple price movements shows this is not so. That said, the difference in price between cardings and combing wool (the basis) does tell us something. This article looks at what information is given by the carding basis for 19.5 micron wool.
For the better part of the past decade the difference in price between carding and combing wool has gradually narrowed. Any price spread (ie basis) analysis needs to account for this trend. For this reason, this analysis looks at the carding - combing price difference on a rolling 24-month base.
When the difference in price is narrow (as it is now), history shows that future (during the next 12 months) price movements for the combing wool are skewed upward. And when the basis is wide (cardings are discounted heavily in relation to combing wool prices), future movements in combing wool prices are skewed strongly downward. The term “skewed” is used advisedly here as, while the analysis shifts the odds of making a better decision in your favour, it is not a magic bullet that has foolproof foresight.
Figure 1 shows a monthly price series of 19.5 micron full length merino fleece from 1994 onwards, along with a grey-shaded area where the carding combing basis reached a narrow level, using the previous 24 months as a guide. This is the “bull” flag, as it is highlighting periods in the market when the downside for the 19.5 micron fleece price is minimal.
Figure 2 is a similar analysis except that the orange-shaded areas are where the carding combing basis has reached a wide level by the standards of the previous 24 months. When the basis is wide, then the risk to the combing price is downwards.
To an extent you may look at figures 1 and 2 and think that the basis is simply reflecting the high and low levels of the 19 .5 combing price. To an extent this is true, but at times of market extremes it is always useful to have a couple of ways of viewing prices to see if they are well above or below fair value. This analysis gives a view of fair value for the combing price in terms of carding prices.
The current carding combing basis is high. At its 87th percentile for the past two years, this is close to the 95th percentile used as the benchmark level for the bull flag. Table 1 shows the historic price movement for the 19.5 micron fleece in three month intervals after a bull flag has been signalled. The complication is that a decile analysis is shown for each three month period so you can see how effective the flag is. For three months forward, the change in price was equally spread between negative and positive, with the rises being much stronger than the falls. By the time we look nine months forward, the combing price has risen some 70% of the time.
Given the strength of the carding market at present, there appears to be minimal downside for combing wool prices in the coming year. So what can go wrong? Well, carding wool prices are at high levels with cotton and polyester prices in the basement, so there must be some downside risk to carding wool prices coming in the next couple of years. However, in markets, timing is everything. For the time being, the downside risk to combing merino wool prices appears to be minimal, perhaps limited to normal seasonal price patterns.
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