Mecardo Analysis - Wool price and exchange rate
- By: "Farm Tender" News
- Ag Tech News
- Oct 23, 2018
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By Andrew Woods | Source: AWEX, RBA, ICS.
A common perception is that Australian commodity prices have a strongly negative correlation with the Australian dollar-US dollar exchange rate so that when the exchange rate moves in one direction, commodity prices move in the other direction. Like all myths, there is an element of truth to this, although the element is quite slim. This article takes a look at the relationship between the 19.5 MPG wool indicator and the Australian and US dollar exchange rate.
The assumption that wool price and exchange rate are negatively correlated leads to “woolly” thinking such as “don’t sell wool when the exchange rate is rising”. The world is a complex place where commodity prices and exchange rates move for a whole host of reasons.
Figure 1 looks at the correlation between the 19.5 MPG and the Australian and US dollar exchange rate for rolling 1 week periods, for the past 18 years. It shows the proportion of time the wool price and exchange rate spent at a range of correlations from plus one (where the two series move in lockstep) to zero (where there is no relationship whatsoever) to minus one (where the two series move in perfectly opposite directions).
In Figure 1 we see the sliver of truth which underpins the common perception of a strongly negative correlation. For about one-third of the time in the past 18 years, week to week the wool prices and exchange rate have been strongly negatively correlated, which leaves two-thirds of the time when the correlation is either weak, zero or strongly positive.
Time plays a big role in correlations. Figure 2 shows the same analysis but for a time interval of one month rather than one week. There is still a skew in the correlation towards the negative end, although the proportion of time when the two series are strongly negatively correlated falls slightly.
Figure 3 shows the analysis using a 4 month time period. The wool price and exchange rate correlation now evens out with no particular bias. The sliver of truth seen in Figure 1 has disappeared, with no real relationship showing up.
Figure 4 extends the time period out to one year and here the correlation is slightly skewed towards the positive end which is contrary to the commonly held view.
Key points
* The 19.5 MPG and AUD-USD exchange rate tend to be slightly negatively correlated in the short term (for around one-third of the time).
* As the time period is lengthened the correlation falls away.
* When looking at changes in the 19.5 MPG and the exchange rate across intervals of one year, the correlation is slightly skewed to the positive end.
What does this mean?
Using exchange rate information, at the grower level, to help in decisions about wool sales is a waste of time, or even worse, a distraction. In the very short term, there is a slight skew towards a negative correlation, in other words, Australian dollar auction prices vary with the exchange rate because wool prices are specified in US dollar terms (to a degree). As the time period lengthens this mechanism breaks down so that when looking at changes across a four-month period there is no real pattern.
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