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11 December 2013

Who'd be a Forecaster......

During the summer, I enjoy sailing my boat around the Solent and western Channel, so I have a natural interest in weather forecasts. Those produced by the UK Met Office and broadcast by the Maritime and Coastguard Agency are, in general, pretty good, if you are interested in what is going to happen in the next few days (mind you, the old sea dogs reckon they can tell the next few days without needing any help from the professional forecasters). Beyond the next few days, though, reliability is far more difficult, and the Met Office themselves stopped broadcasting publicly their long-range forecasts after the embarrassment of the ‘barbecue summer’ prediction of 2009. For those not in the UK, it was hopelessly wrong – it rained like it was going out of fashion. There are lots of amateurs, though, who persist in making forecasts, despite the fact that the professionals with massive computer power believe that weather systems are too unpredictable to make it a valid exercise. As a layman, I interpret that to mean that there are simply too many variables at play to allow anything more than a marginally educated guess, in which light the amateur predictions should be read; they may be right, they may be wrong.

Forecasts and Markets

So what has that got to do with metals and markets? Well, forecasts, really. Our lives are dominated by them; price forecasts, growth forecasts, interest rate forecasts, and all the rest. Like weather forecasts, short-term is not really that difficult, because the range of possible outcomes in the short-term is more restricted – both in terms of the input and the conclusion. In simple terms, guessing what will happen in the near future is relatively straightforward (unless of course it’s a horse race and you don’t have any contacts). Longer-term, though, it’s all much more complicated. First of all, what do you look at? Macro economics? Physical fundamentals? Technicals – and if these, then which ones? Fibonacci numbers? Waves (Elliott or Kondratieff)? Momentum indicators? Monte Carlo Simulation? There’s a lot out there to absorb and make sense of.

Relevance of the Long-Term

Now, definitely on the LME and I suspect in many other traded markets, the short-term is in vogue. The volume of trades made up by algorithmic and high-frequency traders tells us that. So a lot of the market is largely able to ignore the long-term and concentrate on nearby trading. As simple LME traders, we’re probably content with that. Recently, though, I had a conversation with a friend who is a mining entrepreneur, and I was reminded that for mine investment, some form of valid future price projection is essential to make the capital spending decision. Without that, it’s basically a shot in the dark; or, miners will be very cautious, and only undertake projects with a very high hurdle rate of return, in order to give themselves the maximum protection.

Variables and Outcomes

While it is reasonable to agree that no forecasters can be expected to predict the ‘black swan’ events (if they could, they wouldn’t be black swans), it is sometimes difficult to take predictions seriously. Global economies have been suffering the effects of the bursting of the bubble in 2007/08 for a few years now, and yet we have still seen some extremely high forecasts. I’m thinking of the “$12000 copper” that has reared its head, even within the last two years, or the ‘$2400 very soon’ aluminium (summer 2012). This is not being wise with the benefit of hindsight; I and many others said at the time that those sorts of numbers were pie in the sky. Yet those who made those predictions were no doubt using generally accepted economic models. Simply, their inputs were wrong. And that’s really the point; like the weather, the number of variables and thus the range of possible outcomes are both enormous. However rigorous the modelling, at some time there comes the point where a subjective decision has to be made, and therefore the forecast will be subject to human fallibility. It seems strange to say, but I think it’s true, that it is probably easier to model a moonshot, which relies on the laws of physics, than to predict the course of the economy, and therefore market prices, which rely on unpredictable human behaviour. So perhaps we should have more sympathy with the analysts who try.

And now for Something Completely Different...

I can’t leave this, though, without the story (which I believe is true, but I’d better add may be apocryphal) of an analyst from a respected institution who recently told a conference audience that the commodity supercycle wasn’t necessarily dead, it was just like the parrot in the Monty Python sketch. Mmm. My understanding of that sketch was that the parrot most definitely was dead, and the only person who maintained it wasn’t, was the salesman trying to sell it. Not, I think, the message a financial institution would be trying to put across.

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