IMF Working Paper
Do Commodity Futures Help Forecast Spot Prices? Prepared by David A. Reichsfeld and Shaun K. Roache
Authorized for distribution by Thomas Helbling
"Summary: We assess the spot price forecasting performance of 10 commodity futures at various horizons up to two years and test whether this performance is affected by market conditions. We reject efficient markets based on in-sample tests but, out-of-sample, we find that the forecast from the futures market is hard to beat. We find that the forecasting performance of futures does not depend on the slope of the futures curve, in contrast to the predictions of well-known models of commodity markets. We also find futures’ forecasting performance to be invariant to whether prices are in an upswing or downswing, casting doubt on aspersions that uninformed investors participating during bull markets impede the price discovery process."
"...We arrive at four main conclusions regarding the forecasting performance of commodity futures prices in this paper. First, futures price-based forecasts are hard to beat. Futures prices perform at least as well as a random walk for most commodities and at most horizons and, in some cases, do significantly better. But the second result is that the failure of futures prices to clearly (and statistically significantly) outperform this benchmark in almost all cases is a puzzle. The spot price reflects the cost of carry and is more influenced by current physical market conditions (and less by expectations of the future) than is the futures price. In the absence of constraints on arbitrage, this should mean that futures prices outperform the random walk, on average. Third, many other naïve time series models, including some that maximize in-sample fit, tend to do much worse than a random walk. Parameter instability renders many time-series models as useless, at best. Fourth, the relative forecasting ability of futures prices deteriorates the longer the forecast horizon, which likely reflects lower liquidity at the back end of futures curves...."
"We also assessed the forecasting performance of futures prices relative to a random walk during different market conditions. Theory predicts that futures prices should do much better than the random walk when the market is in backwardation because the influence of current market conditions on spot prices is particularly strong during these periods. However, we do not find a significant difference in forecasting ability between periods of backwardation and contango. This result holds even when spot prices are significantly above futures prices, in strong backwardation. What can explain this result? Over small sample periods it is possible that permanent shocks that increase prices could lead to better “forecasts” by spot prices. But over long periods and assuming a symmetric distribution of shocks, this cannot be the explanation. Segmented markets could also explain this result, with backwardated markets reflecting different and better information in the spot market about future spot prices than futures markets. But this would require strict and unrealistic limits to arbitrage; what would prevent spot market participants from simply buying cheaper futures contracts? We believe this apparent puzzle would benefit from further research...."