Peak to trough cycle patterns for 19 micron

Merino sheep in front of gate

The greasy wool market fell heavily early in the season, reaching a low point at the end of August/beginning of September. While down cycles vary in terms of time taken and the size of the fall in price from the previous peak, they do have some common structures. This article takes a look at cyclical downturns, a pertinent topic given the uncertainty present in other markets.

Figure 1 shows the 19 MPG in nominal Australian dollar terms from 1970 to the current month (monthly average prices). The 1988 peak stands out but keep in mind wool production has changed greatly. In 1988 19 micron was some 3 microns finer than the average merino fibre diameter, equivalent to 15.5 micron in the current market. The 2018 cycle stands out as the next largest cycle in nominal terms, which can be misleading.

In Figure 2 the increase in the 19 micron indicator from the lowest price in the previous five years is shown from 1970 to the current month. This is the trough to peak measure. The monster cyclical peaks were 1973 and 1988 where prices peaked at four times their previous cyclical lows (an increase of 300%). The most recent cycle (2018-2019) was a more sedate cycle, rising by 100% from the preceding cyclical low.

Peak to trough cycle the data has been trimmed to the past two decades, as the Reserve Price Scheme dampened down cycles until it blew up in which case it amplified the early 1990s cyclical downturn. Figure 3 shows the fall in the 19 MPG compared to the highest price level of the preceding five years and runs to this month. The maximum extent of the average cyclical down turn for the past two decades has been around 37%. The current downturn is sitting around 25%, fairly minor and on par with 2008-9.

The fear is that economic effects of COVID-19 will deepen and extend the current down cycle in the greasy wool market.

Time is the other factor (in tandem with price) for cycles, with the average cyclical downturn taking around 18 months to reach the low point. In Australian dollar terms the current downturn is now 18 months old, an average age for prices to find a cyclical base. Exceptions do happen as seen in the 2003-2005 down cycle which dragged on, taking prices lower than the initial 2003 price fall.

A subjective reading of the down cycle patterns suggests the main downward leg in price is made initially, with the subsequent price action and timing varied according to conditions operating at the time. That reading suggests we have seen the majority of the price falls for the cycle (not necessarily all) which in turn suggests that a decision to sell forward 100 cents under the market needs to have some good underlying reasons beyond a simple fear that prices may fall. Keep in mind that supply of merino wool remains low and will not recover quickly, regardless of rainfall.

What does it mean?

COVID-19 is causing general uncertainty and volatility in many financial markets. The greasy wool market is some 18 months into a cyclical downturn. It reasonable to project COVID-19 extending the down cycle (due to effects on retail sales) but its effect on price is less clear.

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Key Points

  • For the 19 MPG the current down cycle is an average 18 months old, with a minor fall of 25% as seen in 2008-2009.
  • 19 MPG down cycles during the past two decades have made most of their price falls by 18 months into the cycle.
  • This suggests that hedging at discounts from the current market needs to be done with caution.

Click on graph to expand

Click on graph to expand

Click on graph to expand

Data sources: AWC, WI, AWEX, ICS 

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