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Tuesday, March 01, 2016

Merino production and cotton stocks

By Andrew Woods  |  Source: AWTA, AWEX, ABARES, ICAC, ICS

Key points

  • The drop in production of broad merino wool since the mid-1990s explains around 80% of the big increase in the price ratio of the 22 MPG to cotton.
  • Now that the supply of broad merino wool has stabilised (droughts allowed) at low levels, production alone does not explain the price ratio very well.
  • To help explain the 22 MPG to cotton price ratio a mix of production and cotton stock levels is required.
  • About two thirds of the 22 MPG to cotton price ratio can be explained by a broad wool production levels and cotton stocks.

2016-03-01 WOOL FIG1

2016-03-01 WOOL FIG2

Merino wool prices continue to fly through the commodity price storm that has hit various commodities such as oil, cotton and the metals hard. While cardings continue to take the lime light as the best performer of all, broad merino combing prices are also performing very well. This article looks at the fundamentals underpinning this performance.

Figure 1 shows a comparison of the volume (in millions of farm bales) of 21-23 micron wool (AWTA core test volumes) from 1995 to 2005, with the price ratio of the 22 MPG to cotton. In the 1990s the Australian clip produced 1.7-2 million bales of 21-23 micron wool. Production is now around 0.5 million bales. With the fall in Australian production the price ratio for the 22 MPG has risen from a round 2.5 to anywhere between 4.5 and 6.5.

While the trend line shows why the price ratio has doubled/tripled since the mid-1990s, production alone does not do much of a job now telling us if the price ratio should be 4.5 or 6.5. In technical terms the correlation between production and the price ratio during the past decade has been a negligible one.

In the way of models we need to change the model to reflect the changed circumstances of the wool industry. Figure 2 shows a model of the 22 MPG price ratio to cotton for the past decade, which uses the production data from the second half of Figure 1 and cotton stocks. These two factors can explain about two thirds (63% to be precise) of the 22 MPG price ratio to cotton. As Figure 2 shows the model is not perfect but it gives a fair idea of the likely price ratio.

Why is the price ratio of 22 MPG to cotton important? The wool market operates within a complex web of interrelated apparel fibre markets. The price ratio allows us to look at the price relativity of wool, in this case to cotton, which allows all those other factors that are pushing apparel fibre prices up and down to be allowed for. 

What does this mean?

The Australian production of 21-23 micron wool has fallen by 80% since the mid-1980s. This massive fall in supply has underpinned a big increase in the broad merino to cotton price ratio. Now that the supply of broad merino wool looks to have stabilised (droughts excepted) production levels alone do a poor job of explaining the wool to cotton price ratio. A combination of wool production and cotton stock levels explains two thirds of the broad merino to cotton price ratio of the past decade. This highlights that wool prices are a function of both wool production levels and what is happening in other apparel fibre markets.

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