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Thursday, June 11, 2015

What do wool and industrial commodities have in common?

By Andrew Woods, ICS  |  Source: IMF, AWEX, RBA

Key points

  • Industrial commodity prices, as measured by the IMF industrial materials index, remain at low levels by the standards of the past five years.
  • With the exception of 2002 through 2006 the 21 MPG has a high correlation with the industrial materials index.
  • The index explains around three quarters of the wool price before 2002 and since 2007.
  • Industrial material commodity prices are reflecting demand factors that are common to the wool market (with the exception of wool fashions).

2015-06-11 Wool And Commodities FIG 1

2015-06-11 Wool And Commodities FIG 2

Wool prices respond to economic conditions in a manner similar to industrial commodities, as wool is the raw input for a supply chain that produces mainly apparel. The International Monetary Fund (IMF) provides a series of commodity prices. And from these prices, it produces a range of indices, one of which is an industrial materials index. What’s the relationship between this index and the 21 MPG, and what does it tell us?

Figure 1 shows the rolling five-year price rank for the 21 MPG in US dollar terms and the IMF industrial materials index, which includes energy, metals, lumber, cotton, wool and hides. The wool component is quite small, so it is not really able to influence the correlation greatly. As the index is a compilation of a range of commodities, it reduces the effect of any demand/supply shock that occurs for a particular commodity. This makes it a good benchmark against which to compare wool prices.

When looking at the price rank (figure 1), the two price rank series follow each other closely, except for the period 2002 through 2006. In 2002, the wool market went its own way following the final liquidation of the official stockpile in mid-2001. Price rises in 2002 followed a regular pattern that accompanies stockpile liquidations from the previous half century.

Following the peak of wool prices in 2003, the wool market underperformed through the dim dark days of 2004 and 2005, as if the markets were evening up on the 2002 outperformance of wool. Since 2007, the series have moved back into line, until recent months. Wool prices have rebounded strongly since March, while the industrial commodity materials index has remained low. Some components of the index, such as oil and lumber, have lifted strongly, but overall the index remains low by the standards of the past five years.

Figure 2 shows the actual 21 MPG in USD terms and the IMF industrial materials index from the mid-1980s onwards. The wool price series tends to be more volatile than the index. This is logical as the index is compiled from a wide range of commodities. Correlations between the 21 MPG and the index are much higher for the rolling five-year price ranks (where we compare whether the series are cheap, expensive or neutral in relation to recent historical levels) than for the raw price data.

What does this mean?

The industrial materials index, from the IMF (and other similar indices), are a reasonable guide as to whether wool prices are simply tracking the general path of industrial commodities or whether they are going their own way. Since 2007, the 21 MPG and the IMF industrial materials index have tracked each other closely, especially in terms of a rolling five-year price rank. Since March, wool prices have risen strongly, with the five-year price rank for the 21 MPG in USD terms rising to around the 60th percentile. In contrast, the rank for industrial commodities generally remains low. Supply is basically unchanged, and the index and wool are exposed to similar economic conditions. So the wool price rise looks to be due mainly to a positive change in fashion for cardings and crossbred wool.

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