By Andrew Woods | Source: WI, AWEX, ICS
What does good hedging have in common with comedy? The answer is timing. If we knew when the tops and bottoms of cycles were happening we would all be driving the proverbial Maserati. This article looks at the current wool price and uses past down cycles to get a feel for the potential risk in the market.
In Figure 1, a price series is shown in Australian cents per kg terms for the average merino micron price from 1992 onwards. The prices are monthly averages, which smooths some of the intra month price variation. At the end of Figure 1, on the right hand side, are three projected price series extending out by 2 years. The three projections are taken from major down turns in the wool market during the past 40 years with the median downturn projection simply the middle fall in price seen after the market has peaked. The severe and mild down turns show the more extreme range experienced, and have a lower probability of developing.
In terms of time taken, the median downturn shows that the market loses most of its value in the first 12-15 months after the price peak. The severe downturn extends the price fall while the mild downturn weakens for about 6 months and then steadies.
In terms of price fall, the median downturn sees the price fall by around 30%, the severe downturn by 50-55% and the mild downturn by 10%.
Figure 1 shows there are two crucial views to be formed with regard to selling forward in the wool market. Firstly, a view on the timing of the price peak (or thereabouts) needs to be made. The fine merino market looked to have peaked around May but has now jumped to new highs, which demonstrates the trickiness of this process. Secondly, a view needs to be formed about the likely depth of potential down cycles – are we looking at a standard down cycle, a mild one or a tough one? This latter view helps determine what looks to be a good forward price.
During this price cycle, there have been more minimum price contracts available than usual, albeit still relatively scarce which is understandable given the thin forward market for wool. These contracts do allow some of the price to be covered while allowing upside if the market continues to trade at high levels.
At this stage economic growth in the developed economies remains quite good with only a slowing Chinese economy in 2018 causing some concern for downside risk as 2018 develops. That seems to indicate downside somewhere between the mild and median for 2018, after the market has peaked, which at this stage is still unknown.
The down cycle, when it comes for merino wool, is likely to be in the range of 10% to 30%. Given current price levels a mild down cycle would be a tremendous outcome. A severe down cycle seems unlikely as supply is limited, stocks are minimal and the macroeconomic background is positive. Slowing Chinese growth in 2018 seems likely to take some of the sting out of the market, but as yet we have yet to see a cyclical peak in prices.
Mecardo information is provided to assist in your marketing decisions. It contains a range of data and views on the current market. It is not intended to constitute advice for a specific purpose. Before taking any action in relation to information contained within this report, you should seek advice from a qualified professional. The information is obtained from a variety of sources and neither Mecardo nor Ag Concepts Advisory will be held liable for any loss or damage whatsoever that may arise from the use of information or for any error or mis-statement contained in this report.
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