🐑 Your Guide To Investing In Wool, A Surprisingly Versatile Commodity Not Only Used In Textiles

Brief Background

There are actually different types of sheep’s wool, depending on the breed of the sheep. Generally speaking, wool ranges in its thickness, ranging from very fine, to coarse. Because of this, there are many woollen products that can be made, ranging from super soft, lightweight apparel that doesn’t itch, to durable carpets. Freshly sheared wool from a sheep is known as greasy wool, the commodity we’re talking about today. It’s called greasy wool because it still has high levels of lanolin, a natural, waxy substance produced by the sheep. This byproduct of wool production also has its uses, with a sizeable global market.

What Can It Do For You

🧺 Portfolio Diversification. As always, adding commodities to your portfolio can help diversify and lower risk. Adding wool to your portfolio means owning an asset that tends to act differently to other asset classes, and even to other commodities. So, it may be best to bundle it with a number of other commodity varieties to achieve diversification. This is to help mitigate the impact of market volatility of any individual commodity on your portfolio.

💰 Profit. Due to high market volatility, wool can provide decent returns should speculative traders and investors aim to profit from the market. Compared to other fibres, wool is pretty niche, and it competes with other, usually cheaper substitutes too. Additionally, consumer preferences and trends are continuously changing. This results in the highly volatile market we see today. In the long term, there are a number of trends that could support and boost wool prices. These include new developments in wool-processing technology and emerging market demand — growth opportunities. However, there are a number of risks that could certainly put downward pressure on wool prices. These include overproduction or stock oversupply by farmers, and shifting consumer preferences favouring other fibres.

What Affects Wool Prices

There are several key factors that are involved in moving the price of wool:

• 🇦🇺🇨🇳🇳🇿 Australian, Chinese & New Zealand Production. Australia is the biggest producer of wool, accounting for roughly 23.4%. China and New Zealand produces 15.5% and 9.1% respectively. These three countries produce almost half of the world’s wool, so any supply disruptions in these countries could have an impact on prices.
• 🌍 Global Economic Strength. Wool creates consumer discretionary products. So, when the global economy is weak, consumer demand may be lowered. Similarly, when it’s strong, with higher discretionary income, consumer demand may increase.
• 🇺🇸🇨🇳 Global Demand (Especially China & The US). Although wool is considered to be a high-value, niche product, it’s a globally traded commodity. The US is the largest importer of woollen textiles and apparel, and China is a major consumer of woollen products.
• 🛍️ Consumer Preferences & Fashion Trends. Changing consumer preferences and fashion trends can determine consumer demand for woollen products. For example, consumers are increasingly choosing lightweight apparel fabrics for active/leisure wear, increasing demand for finer wool. Another is the seemingly growing shift towards smart casual attire in the workplace, reducing demand for suits.
• 🏛️ Government Policy. Policies such as import/export tariffs and subsidies can certainly have an impact on supply and demand levels, and therefore, prices. For example, during the US-China trade dispute, the US increased import tariffs on Chinese woollen apparel by 15%. This pretty much decreased demand on the US side.
• 📈 Stock Levels. Similar to other commodities, stock levels can also play a part in moving prices as it can provide insight into supply and/or demand levels, which can then lead to speculation in the market. The difference in wool’s case is that it’s not necessarily the greasy wool stock levels that matters. Rather, it’s the stock levels of yarn and wool tops, the processed and semi-processed products to look out for. If there are high levels of yarn and wool tops, spinners and mills don’t have to buy more raw greasy wool, decreasing demand. Alternatively, if stock levels are low, then this could increase demand for greasy wool as spinners and mills keep up to meet demand.
• 🔄 Substitution. As a fibre, wool competes with both oil-based synthetic (e.g. polyester) and natural (e.g. cotton, silk, etc.) fibres. So, if wool prices are higher than the others, this might lower demand as consumers have a number of alternatives to choose from.
• ☀️ Weather. You might be surprised to know that adverse weather conditions (like prolonged drought periods) can also impact wool supply. For example, with a drought, farmers would have to choose whether to keep hand feeding and watering them at potentially a higher cost, or sell the animals and keep the wool to sell at a later date. It also depends on wool prices. If wool prices are too low, farmers may not be willing to sell, and would prefer to wait, which could lead to a situation of oversupply, and therefore, prolonged periods of depressed prices.
• 🇦🇺 Australian Dollar Strength. Unlike a lot of the other commodities, the benchmark for the pricing of wool is in Australian dollars. A weak Australian dollar compared to other currencies (i.e. need more AUD to buy other currencies) may incentivise foreign buyers to buy (since their currencies are worth more in AUD & so can buy more wool) & drive up demand, increasing prices, and vice versa.

Australian wool production and outlook. Unfortunately, there’s no publicly available information about world production and consumption of wool, but because Australia is the biggest producer of wool, with an actively traded wool futures market, production numbers here can provide a snapshot of overall supply in the market.

What Is It Used For?

As mentioned above, freshly sheared wool, or greasy wool, produces both wool and lanolin. Because there are different types of wool, ranging from fine strands to coarser ones, there are a variety of uses cases. Here are some of their uses:

• 👕 Clothes. One of wool’s most obvious uses is clothing, knitted into a variety of items such as sweaters, suits, coats, scarves, socks, gloves, etc. Consumers range from students (school uniforms) to the wealthy (bespoke suits and dresses).
• 🧶 Carpets. Coarser types of wool can be used to create carpets.
• 🛏️ Furnishings. Various household furnishings can also be made out of wool. These include various wool bedding items, upholstery, and other soft furnishings.
• 🌡️ Insulation. Wool can also be used as insulation to keep buildings warm.
• 🧴 Lanolin. Lanolin is a waxy substance used in personal care, cosmetic, and baby products, and is also used in pharmaceutical and industrial industries. According to various market research firms, the global lanolin market size itself was about USD 290 million in 2019.

The Case Against Wool

There are a couple of risks involved if you want to get involved with wool. Firstly, because of lowered prices in recent years, farmers have been stocking the wool to sell when market conditions are more favourable. The problem with this is that this stock accumulation can further dampen wool prices because of an oversupply in the market. Secondly, wool is very much a consumer discretionary product, the demand of which changes depending on economic strength, consumer preferences and trends. One example of this is the growing trend of smart casual attire in the workplace instead of suits. Last but not least, the fibre industry is a competitive one with a range of options, with both natural (wool, cotton, etc.) and synthetic. Cheaper substitutes and changing consumer preferences can impact demand. All this means that wool prices are very sensitive to any changes in supply and demand.

The Case For Wool

Overall, there are two general trends that could support wool prices in the long-term. Firstly, as with a number of other commodities, demand from emerging economies, especially China, can certainly grow as their economies grow. China is already a major consumer of a variety of woollen products, and consumer demand may grow as more citizens have more disposable wealth. Secondly, the wool industry have responded to changing consumer preferences and trends by developing better quality, fine wool to create various lightweight, thin apparel items for active and leisure wear. This can certainly help boost demand for wool products in the future.

Popular Ways To Invest In Wool — Pros/Cons of Each

You’re quite limited in how you can easily invest and get exposure to wool. The only real, direct way is through wool futures, offered by the Australian Securities Exchange (ASX), but as mentioned in previous articles, futures contracts can be quite complicated if you’re unfamiliar with them. If you’re still confused about how any of these work, refer back to our basics newsletter for a refresher.

• Wool ETFs. Unfortunately, there are no ETFs or ETNs that focus solely on wool, but there is an ETN that invests in a diversified group of commodities, including wool. That being said, it represents only a tiny percentage of the overall portfolio, so you won’t have full and direct exposure to wool prices. Regardless, they’re traded on stock exchanges, so they’re pretty easy to buy and sell. Depending on which broker you go with, you may be charged with trading commissions. ETF/ETNs also charge an expense ratio, or management fee that gets taken out of their total holdings and is then reflected on your account. Be sure to read the fine print & understand the risks and costs involved.
• Wool Stocks. You’re also quite limited here. There are publicly traded companies that deal with textiles, including wool, but they may be listed on various foreign exchanges. Furthermore, they might also be involved in other types of fibres, like cotton or synthetic fibres, so you may not necessarily be following wool prices since there are other factors at play. As always, you may want to consider looking at the company’s annual reports (especially operational costs), portfolio of what products & assets they have, what research & development they’re currently conducting, and potential expansion plans.
• Wool Futures Contracts. The Australian Securities Exchange (ASX) offers two types of wool futures contracts — greasy wool and fine wool. Both contracts represent 2,500 kilograms of wool, or about 20 farm bales! When the contracts expire, the greasy wool contracts are physically settled, whereas the fine wool contracts are financially settled. As a reminder, futures contracts are binding agreements traded on futures exchanges between two parties where they agree to buy/sell wool at a specified time in the future with an agreed-upon price. Because you are using a significant amount of borrowed money, even small price changes in wool can either lead to massive profit, or massive losses beyond what you paid for, potentially leaving you in massive debt. They are certainly high-risk and not recommended for beginners. Further, fees associated with futures trading include broker commissions, and exchange/clearing fees.

TL;DR — Is It The Right Investment For You?

As always, it depends on what your aims are. As an agricultural commodity, bundling up wool with a number of others can help you achieve portfolio diversification. The current situation is such that due to low prices in recent years, farmers have been accumulating wool to sell when prices are higher. This then puts downward pressure on prices because of an oversupply in the market (too much stock). Furthermore, since wool produces various discretionary products, consumer demand can change depending on economic strength, consumer preferences and trends (e.g. growing trend of smart casual attire in the workplace instead of suits). On top of this, consumers also have a number of substitute options to choose from, ranging from other natural fibres like cotton, to cheaper synthetic ones. All this means that wool prices are very sensitive to any changes in supply and demand. That being said, volatility in the market presents opportunities for the more speculative traders and investors to profit and time the market. In the long-term, there are two trends that could support wool prices: emerging market growth, and developments in better quality wool fibres. China is already a major consumer of a variety of woollen products, and consumer demand may grow as more citizens have more disposable wealth. Furthermore, the wool industry have developed better quality, fine wool in response to changing consumer preferences, creating various thinner, lightweight apparel products suited for active and leisure wear. This can certainly boost consumer demand.

🧺 If you are considering wool to your existing portfolio or bundling it with a number of others, you may want to consider doing dollar-cost averaging (regular investments over time) to build your wool position so you can take advantage of any volatility in the market.

💰 If you are considering adding wool for speculation and profit, you may want to monitor the factors that affect wool prices mentioned above. There are several free resources you can tap into to gain insight into wool. The Australian government releases quarterly outlook reports, providing a snapshot of the current situation, in addition to projections in the future. Australian Wool Innovation (AWI) provides weekly price reports, monthly market reports, and quarterly wool production forecasts. In addition to monitoring the factors mentioned above, you may also want to consider performing some technical analysis on wool’s price chart to help consolidate trends and patterns to help with your decision. That being said, its prices can also swing unexpectedly and dramatically, so be prepared and have an exit plan in place.

As always, if you are unsure, check in with a professional financial advisor before making any moves.

Thank you for reading! Let us know if you found this helpful. You can connect with us @VNewsletters, or check out our website for more information @ vaultcomms.com.