Introduction:
This week’s article is actually highly applicable, potentially profitable and generally useful. The idea that one can make money by predicting the future is an old fantasy. Many people often dream of making loads and loads of money by investing in the stock market and living a life of absurd luxury. Now, these people needn’t be dreamers any more. Doctors Sanders and Manfredo published an intersting article in The Journal of Business Forecasting, an aptly named publication, regarding strategies for investing in futures markets.This is a relatively simply yet effective strategy with a whole host of applications.
Summary:
Futures prices for almost any commodity (coffee, lean hogs, corn, cocoa) are readily available to the general public and adept investors can use this publicly available information to guide their investment strategies. In the case of this article, the doctors use the price of diesel fuel to forecast the likely price of heating oil in the future. Many firms that negotiate futures contracts often use this information to produce estimates that are often more accurate than those distributed by government experts.
Futures prices are essentially established by determining a difference or a ratio. Differences are found through the equation:
Basis=cash-futures
Where raiots are found through the equation:
Basis=cash/futures
In both of these equations the basis is the historical average price of the commodity during a given time. As we can see from their charts, the price of fuel changes with the seasons and does not remain constant throughout the year.
By looking at the historical information (in the chart below) one can take the historical average price ratio across three years (2001-2003) between retail diesel fuel and heating oil. Then establish a forecast in the future by applying the simple formulas above.
Conclusion:
Essentially this information is a quick and cheap way to determine possible commodity futures. It doesn’t account for outliers and events that may skew the data. However, as a general practice it can readily be used as the foundation for sound estimates.
Source:
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Karl, Excellent article. I think that the US could use this information particularly when looking to insulate its own agriculture from external forces, perhaps in subsidies or other areas of government control. Especially when you apply this analysis to foreign markets, I think the technique would be able to reduce a large amount of uncertainty for decision makers.
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