Some 80% of Australian wool production is processed in China, so the Australian to US dollar exchange rate is the key exchange rate for this wool flow. Figure 1 compares the eastern 19.5 MPG in Australia and US dollar terms from 2000 through to this month. The graph shows that the 19.5 MPG follows similar cycles and trends in both currencies, with variations in the change in value. On the whole the two series are positively correlated, illustrating that the exchange rate is a secondary factor in pricing.
Figure 2 shows the distribution of week on week correlations between the 19.5 MPG in Australian dollar terms and the Australian to US dollar exchange rate, from 2000 through to 2022. The correlation ranges from 1.0 (where the two series move in lockstep – perfectly positively correlated) to -1.0 (where the two series move in completely opposite directions – perfectly negatively correlated). The line shows the cumulative proportion of correlation as the correlation ranges from +1.0 to -1.0.
There is a skew to being negatively correlated in Figure 2, which fits with the common perception that Australian priced commodity prices and the exchange rate move in opposite directions. However note that some 30% of the time in the 22 years between 2000 and 2022 the 19.5 MPG was positively correlated to the Australia/US dollar exchange rate to some degree. On the other hand the 19.5 MPG and exchange rate are negatively correlated, to some degree ranging from a weak to perfect correlation, 47% of the time. What Figure 2 shows is that while the wool price is more often negatively correlated to the exchange rate there are significant amounts of time when this is not the case, and the situation can be reversed. Knowing when this will be the case is most uncertain.
To illustrate the variable nature of the week to week relationship between the 19.5 MPG and the Australian US dollar exchange rate Figure 3 shows the weekly change on a daily (eastern auction sale days) frequency from 2000 through 2022. There are periods when the correlation skews towards strongly positive and (less so) strong negative), with a lot of the time the correlation swinging wildly across the range of possible correlations. The message is that on average exchange rate movements tend to be negatively correlated there is a lot of the time when it is not, and forecasting these changes in correlation is certainly beyond this writer.
What does it mean?
Often movements in the exchange rate can be seen to have an effect on local Australian dollar wool prices, as during the past couple of weeks. However, it is a mistake to assume the relationship between wool prices and the exchange rate is a fixed, negative correlation. The relationship swings from strongly negative to strong positive and in-between where there appears to be none.
- In the bigger picture the exchange rate is a secondary driver of the 19.5 MPG price level.
- While the correlation between the 19.5 MPG and exchange rate is skewed to the negative side, during the past 22 years the correlation has been positive to varying degrees.
- The relationship between the 19.5 MPG and exchange rate is highly variable, don’t assume it is fixed.
Click on figure to expand
Click on figure to expand
Data sources: AWEX, ICS
Photo Credit: Carmen Lee Campbell “Sea of Sheep”