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.