In this edition we want to introduce you to a new tool we have developed to generate insights into post-farm gate stocks of greasy wool in Australia.
Modelling stocks of greasy wool held post-farm gate in Australia
One of our major weaknesses in our ability to understand wool price movements and outlooks has been trying to get a handle on the stocks of greasy wool held post-farm gate – those bales of wool held in the stores of brokers or others, such as private merchants. Such stocks can quickly flow onto the auction market in response to positive price movements, as notably happened 12-18 months ago, or to buyers and exporters outside the auction room. When these stocks available to wool buyers get to low levels, it theoretically can act to increase pressure to operate within the auction room, and vice versa.
The Woolmark Company has been quietly developing a model of these post-farm gate greasy wool stocks for about 18 months now, and feel it is time to share some insights arising from our efforts. Our model utilises wool volume inputs from ABS, AWEX and AWTA, to estimate the result of flows of wool into and out of the auctions system, and out of Australia. At this point, we do not attempt to model these flows within specific diameter bands, and have restricted our timeframes to the period from January 2002, six months or so after the wool stockpile was acquitted. Wool prices are not an input, since our intent is to try explain or anticipate price movements.
The following chart compares movements in the EMI (in Australian cents) with movements in our index of wool stocks held, where we express the stock levels relative to our estimate of the peak stock level achieved in the period since January 2002 (December 2003). The reason we have chosen to express stock levels this way is that at this point we are most interested in the direction of stock changes, and comparative levels across time, than trying to predict absolute numbers of bales. In any case, we don’t have a declared starting volume of stocks to work with.
A couple of things to note:
- In general, stock levels are negatively related to price movements. Since January 2002, the correlation between EMI (AU) and stock levels has been 69%, rising to 90% if we consider only the 41 month period shown in the chart. This negative correlation is what we intuitively expect – falling open cry auction markets (a proxy for demand) leading to greater passed in rates and stock accumulation, and vice versa.
- July 2011 represented the low point of of the stock index, following a rapid run down from December 2010 levels – reflecting the extraordinary (55%) price rise which occurred through the period.
- In the 5 months which followed (to December 2011), stocks appear to have accumulated rapidly again, probably reflecting the downward trend in wool prices, and narrowing of micron-price differentials.
- Since then, both stocks and price have trended downwards – such that the stock index is now close to the lowest point, achieved last July. While this recent reduction in estimated stock levels may seem counter-intuitive, our discussions with some in the trade suggest it reflects reality: auction prices remaining strong in a historical sense, auction offerings relatively low, but significant wool sale volumes are occurring outside the auction system, as seen in ABS wool export volumes.
And so it seems to us that the market is heading into the July recess and the subsequent new season with extremely low post-farm gate stock levels, having quietly run down stocks over the prior 6 months.