THE Australian wool industry has had an active forward pricing mechanism in place since 1960 with the country’s first futures market founded as the Sydney Greasy Wool Futures Exchange.
Grower participation has ebbed and flowed throughout the years as downstream markets, price levels and government regulation changed the landscape.
The introduction of the Reserve Price Scheme in 1974, funded by grower taxes, put an artificial put option in the market reducing the necessity of other risk strategies.
The cessation of the RPS and the disposal of the stockpile by the mid 1990s saw a steady revival of participation in wool futures on the Sydney Futures Exchange, which peaked at 56 million clean kilograms (22 per cent of the underling clip) in 2008.
The demise of the leading futures broker, MF Global, in 2011 saw volumes bottom out and the SFE closed the wool contract the next year. Since then the Riemann Wool Contracts have filled the void with cash settled contracts based against the AWEX Micron Price Guides.
The growth in the use of wool forwards has been static for the last few years with the volume steady at around 1.5 to 2pc of the underlining clip (3 to 4 million clean kilograms).
The stagnation can be partially attributed to the consistent rise in prices from 2015 to today, which has seen most micron qualities lift around 70 to 80pc. The key micron indices of 19 and 21 have risen from 1330 cents per kilogram to 2370c/kg and 1260c/kg to 2225c/kg respectively. Volatility has been high and levels have outstripped even the most optimistic forecasts.
The question now is where do we go from here and what strategies can be put in place to navigate the future. Risk management is about margin management and the practice of identifying potential risks to an enterprise, analysing and taking precautionary steps to mitigate or transfer those risks.
The key driver for most commodities will be the balance of supply and demand.
The supply assessment for wool is somewhat straight forward. The current clip forecast has supply for 2018/19 down 5.6pc. The ongoing tight conditions over the majority of wool growing areas point to this being optimistic with some estimates closer to 10 to 15pc nationally.
This will be particularly evident in the mid microns. Added to this is the absence of any significant stocks in the key processing markets.
Demand assessment is much harder. Considerable effort has been expended in demand creation over the last few years with wool usage moving away from a reliance on traditional high fashion apparel and into casual, outdoor, sporting, medical and babywear.
The resultant higher prices have downstream processors questioning the ability of consumers to cope with these rises and are concerned by the risk of demand destruction.
The length of the rise has meant any cheaper stock has already been consumed.
The other demand concern is the potential impact of the current trade war between China and the USA. China is the major processor and consumer of Australian wool taking around 80pc of the clip annually. Around half is consumed locally and half exported with the USA being a key market.
On balance it seems unlikely we will see an extended trend reversal but at these price levels it would be prudent for growers to consider a risk strategy.
We have seen a short term retraction over the last three weeks. The market has come off 180c/kg from the peak with the key 21.0 micron index falling from 2354c/kg to 2174c/kg. The forward market indicates a consolidation at this level, trading earlier this week at 2200c/kg (a premium to the spot market).
Early New Year forward bids are at 2130c/kg, well over the 12 month average of 1950.
In this current climate it is important all participants in the pipeline consider the value of certainty over the fear of lost opportunity.
For growers, the ability to hedge some of their clip well above the cost of production enables them to plan and manage margins and be price makers not price takers.
Being proactive and taking a systematic approach to managing wool price risk means you will be in control of the situation rather than it controlling you – not a bad approach in a volatile market.
- Mike Avery is a Southern Aurora Markets Partner – Wool. Southern Aurora Markets is a solutions provider to the agricultural commodities market, providing effective risk management tools, liquidity and strategic advice to sellers, buyers, banks and investors. Southern Aurora Markets offers the Riemann Wool cash settled ‘over the counter’ forward contract, which is based against the Australian Wool Exchange nominated Micron Price Guides mid-point price of the North and South MPGs.