Opportunity in wool futures

Press, 9 October 1982, Page 21

Opportunity in wool futures

During a period of gloom, as in the last six months, with all markets falling, wool futures have offered New Zealand investors one of the few opportunities to profit from the worldwide economic recession, according to a firm of Auckland sharebrokers. Jordan. Sandman. Smythe and Company say in a wool futures market review that speculators with short positions have shown significant profits as wool futures have lost on average about 11 per cent of their value during the last six months.

Holders of equities, and speculators with long positions.conversely. incurred significant losses. ’ (A short position is an agreement to sell at a future date: similarly a long position is an agreement to buy. The trader going short usually does not possess the commodities he agrees to sell — he will buy those nearer the agreed delivery date).

On their comprehensive review of the international wool market, the sharebrokers say that although futures prices are in a firmly entrenched downtrend, they have been extremely volatile.

Buying has been inspired by ' the possibility of Iran's return to volume wool buying and rumoured devaluations. initially by Australia and then by New Zealand. At this stage. Iran’s purchases have amounted to no more than dribs and drabs.

The chances of a large one-off devaluation by Australia have faded as the Federal Government continues to slide the value of the Australian dollar gradually against their tradeweighted basket. New Zealand’s dollar has been frozen and seems destined to remain frozen like almost everything else until ’ Mr Muldoon lifts his wage and price freeze. Although the N.Z. dollar may be fundamentally overvalued. it seems that political considerations will dominate in the short term. In the context of the wool market, a devaluation, although raising auction prices and consequently futures prices, would be of limited benefit. The largely inelastic demand for crossbred wool means there would be only a

small increase in volumes sold. Higher auction prices would increase Wool Board intervention costs, and lower SMP payments, but would not increase farmers' revenues unless the devaluation raised auction prices the 25 per cent necessary to match SMP levels. At the same time, farmers' over-all costs would increase because of the increased price ol imports. Given the precarious state of farmers' finances now. any further increase in costs could induce negative margins for some farmers, and cause a decrease in production. This would be contrary to the Government's stated policy of stimulating production of agriculturally-based products.

Futures contracts are expressed in terms of type 35 F2D (46 48s). and so far this season this type has been selling between a low of 362 c and a high of 378 c a kilo, as much as 13 per cent below its all-time high. The sharebrokers say that the world is waiting for a reduction in United States rates to initiate an economic recoverv.

Whether the reductions in nominal interest rates lead to a more significant fall in real interest rates and a reversal of the current decline in world economic activity is critical to an increase in the demand for New Zealand crossbred wool. On an annualised basis industrial production fell in

the second quarter of this year by 9.5 per cent in the United States. 4 per cent in West Germany and 7.2 per cent in Japan. The magnitude of these declines illustrates the severity of the world recession, and the lowbase from which growth will take off.

Falling interest rates do. however, offer commodity producers some hope because they may lead to economic revival, provided demand does not increase so rapidly as to start another round of inflation, they say.

"The recovery in prices for agricultural commodities could be slowed further as Producer Boards and Government agencies who have been accumulating the excess production during the recession dispose of their stockpiles. Although these stocks are at manageable levels now, the Government's policy of encouraging agricultural production with no regard to the level of demand means that if demand does not pick up in 1983. NewZealand along with other agricultural producers will be left holding intolerably high stocks. "The question will then be asked whether countries can afford to continue agricultural protectionism to insulate producers from world markets.

“Drought conditions in both Australia and the South Island of New Zealand have cast doubts on production levels for the 1983/84 season.

Australian authorities are forecasting a 7.4 per cent downturn in production for 1983 84. This decrease will be composed of mainly finer Merino wools and will not have an impact on the global supply of coarser crossbred wool.’

"New Zealand's production for 1983/84 will also be under pressure because of the drought conditions in the South Island." the sharebrokers say.

“Although indications are for slight recovery in demand in the 1983/84 season, this increase will be primarily absorbed by the Wool Board selling from its stockpile. Consequently, demandinduced price increases could be minimal. “With no increase in demand for wool forecast for the 1982/83 season we see the only possibility for an increase in prices coming from a downward adjustment of the New Zealand dollar. In the past, less than half of any devaluation has been recovered in the form of price increases. With so much in the Futures Market hinging on a devaluation, largely a political decision, it is difficult to recommend either a bought or sold position. However. we would be reluctant to take a bought position, solely on the prospects of a devaluation in the face of such bearish fundamentals.

“On balance, we believe futures prices for delivery 1982/83 will fall to about the Wool Board's intervention level in the 355-365 cent per

kg clean range, and consequently recommend selling futures in these contract months.

"Futures for delivery in the 1983 84 season are now trading at between a 10 to 14.5 per cent premium over current auction prices. With the uncertainty surrounding the wool market we believe that this premium should be reasonably attractive to manufacturers considering a buying hedge. Despite our bearish view we are hesitant to recommend shorts in the distant months. We believe a bear straddle involving selling a futures contract for delivery in the 1982/83 season or early 1983/84 season, and buying the more distant months, could be profitable. The profit in a bear straddle is achieved when the premium between near and distant months widens, the brokers sav.

The broking firm says that it is interesting that the price target now implied is below recent Wool Board intervention levels. The 10 per cent measured move target would be satisfied at $3.40. In the past. Very strong support has occurred between $3.50 to $3.60. In the present environment, an auction close below $3.60 kg for 35F2D type w-ooi would imply that the market support in this zone could be vulnerable.

In their chart portfolio, the more distant the delivery month, the more optimistic the chart looks, thev sav.