Farm Tender

Are you sure the wool market can only go up?

By Robert Herrmann - Mecardo

The wool market has finally shaken off the disappointing prices of the 1990’s and early 2000’s to currently sit at levels many wool producers have longed for.

As in the past when markets surge, the underpinning fundamentals for the strong market support a positive outlook into the future.

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Record Prices

Most Micron Price Guides (MPG’S) are now trading at almost the highest Percentile level since 1996, with all Merino MPG’s (23 MPG & finer) above the 99% level; that is that since 1996 the market for these MPG’s has traded lower for 99% of the time, and therefore higher for less than 1% of time.

By any comparison, these prices are at historically good levels. AWEX excitedly reported that at the end of the financial year the Eastern Market Indicator (EMI) was “531 cents above the corresponding market last year, almost a 35% increase for the year”.

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With wool production forecast to retreat slightly from last year (prolonged dry conditions on the Eastern seaboard will reduce fleece weights), there is not going to be an increased supply to pressure the market.

In fact, the almost complete lack of any buffer stocks or wool held in brokers stores means that unless growers sell newly shorn wool, there is no wool available to the trade.

So, as one industry figure quoted, “the market can only go up, it can’t go down!“

Since making this statement we must agree that he has been right. The combination of marketing, the eventual commodity upcycle along with constrained supply, provides a good outlook.

At this point, I want to inject some economic thinking. There is a well-worn economic theory:

   * When demand increases, in the absence of increased supply, prices rise.

   * When prices rise, demand is sending a message to supply to produce more.

   * Then when supply increases, in the absence of increased demand price falls.

   * When the price falls, demand is sending a message to supply to produce less.

   * Then when supply falls, with stable or growing demand, prices rise … and so on!

So far, the recent evolvement of the wool market is that what was a case of oversupply and satisfied demand, is now a market that is unable to satisfy demand as a result of the reduced flock/clip, hence prices are strong.

But what happens when demand increases (and pushes prices up) but supply doesn’t increase? It appears nobody knows!

According to the economic experts, there are only 4 things that can change a price: Demand increases, Demand decreases, Supply increases or Supply decreases.... Demand Increase: price increases, quantity increases. Demand Decrease: price decreases, quantity decreases.

Wool is going to test economic theory, demand is strong but is unable to encourage supply to increase. This supports the thinking that prices will not retreat and in fact, can continue to rise in the short to medium term.

Or will it?

There are other factors in the wool equation, firstly wool in the past has had to compete against cotton and synthetics. When prices between competing fibres disconnected it was only a matter of time before a correction. So, unless wool can disconnect from competing fibres, high wool prices can only be sustained if competing fibre prices are also high.

Of greater concern is the possibility that demand will adjust to supply, and when you think about it there really isn’t any choice. No matter how high wool processors bid for wool, there are no additional stocks that can be attracted to the market.

In looking at the recent history showing that about 700k bales of Merino wool has gone from production, demand has adjusted to the new volume. Mills are not sitting empty waiting for the Merino sheep numbers to grow, they have either closed or moved to other fibres.

So demand may adjust despite tight supply!

Get to the point …..!!

Wool is one of the few commodities with a transparent forward market, yet currently, less than 4% of next seasons clip is forward sold. In simple terms, wool growers are “betting” over 95% of their next clip that the wool market is going to be at these levels or better!

Looking back to the Percentile table, in simple terms based on the past 20 or so years, the market is far more likely to go down than up! Admittedly this period has had far less wool for the market than previously, but wool also had a far larger market share then than now also.

What to do?

If you have sold wool in the past few months at levels you would be happy to sell future clips at, then forward sell a portion of the future clip. Whether the market goes up or down, any forward sale at current levels will still be in the top couple of wool sales in history!

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