Preface

Among all forms of mistake, prophesy is the most gratuitous.”

George Eliot

A scandal that broke in the summer of 2008 was to have implications far from China’s shores, arguably sparking a boom in the price of an essential commodity. A boom that eventually turned to bust.

Thousands of babies became sick with kidney stones after ingesting a chemical called melamine. Used to manufacture kitchen and bathroom counter-tops and dry-erase boards, melamine causes renal failure in humans. The chemical also happens to be rich in nitrogen, and so many Chinese farmers added it to the milk they collected to give the impression that it was rich in protein. Babies who were fed the tainted milk then suffered from protein deficiency; their mothers were unaware that the milk powder was not as described on the tin.

Chinese families, scared by the tainted product, looked for safe dairy options elsewhere. Countries as far away as the UK and Australia restricted the sale of infant formula. However, students, tourists, smuggling rings and canny entrepreneurs stocked up on the West’s infant milk powder and then took it back to China or sold it through eBay-type websites in China.

For the farmers of New Zealand (the South Pacific nation is the world’s biggest exporter of milk-based products), this was a big opportunity. It was a chance to capitalise on a short-term demand problem coming from its biggest consumer. But it was also the promise of never-ending demand for dairy products as Chinese consumers turned to more “Western” style diets.

Taking a product, assuming rising demand for it and multiplying that by 1.3 billion Chinese consumers can be a risky game. To meet China’s insatiable demand for ice cream, infant formula and other dairy products, New Zealand’s farmers ramped up production. They went on a buying spree, increasing their herds, purchasing land and converting sheep and beef farms to dairy. As of late 2013, many industry commentators were predicting dairy prices would continue to stay high, although perhaps a little weaker than the record prices.

Boom quickly turned to bust, however, when over the following 18 months dairy prices fell by almost 70%. China had purchased more milk than it needed, and when it found itself awash with milk the dairy exporters, such as those in New Zealand, bore the brunt of the pain, rather than China’s domestic dairy industry. For many farming communities the situation became so desperate that some dairy farmers resorted to suicide, seeing no other way out from the collapse in milk prices, the impact on their incomes and the ability to support their families. The pain was felt right across an industry that stretches from the Pacific to Europe and North America and employs millions of workers.

The outlook for commodity prices is more than just of academic interest. This book is about predictions – why commodity markets are so difficult to forecast, the danger that forecasts may present and how we can all do better. It is about pundits – the bias present in forecasters and how to spot them. Finally, it is also about the pursuit of profit – by investors and all parts of the commodity supply chain.

Underpinning this book is fragility; of the food we eat, the materials we use for shelter and to sustain our standard of living and the energy we use to heat our homes. This book explains how you can make your life, your business and even the economy you work in less fragile. In the words of Nassim Nicolas Taleb, this book is about how to become more “anti-fragile”.

The outlook for oil and other commodity markets are pored over for macroeconomic signals. Whether inflation will rear its head, whether a country’s terms of trade might worsen and whether its energy companies, miners and farmers will see better returns in the months ahead. Prediction is indispensable to anyone involved in commodity markets. Every time you choose what car to buy, whether a farmer plants wheat or corn, whether a manufacturing company takes out a long-term energy contract or not, you are making a forecast about how the future will turn out.

This book has important lessons for how to view many other financial markets, how to interrogate their pundits and how to pick apart their predictions.

This book is for you, the investor.

As an investor, part of your portfolio is likely to include a significant share devoted to resource companies (miners, oil companies etc). So how can you make better decisions about where to devote your capital? This book will help you understand the challenges involved in forecasting commodity prices, providing you with a better list of questions to ask. It will help protect you from being sold a story which isn’t backed up by reality. To paraphrase a quote often attributed to Mark Twain, “A mine is a hole in the ground with a liar on top”. This is too harsh a criticism of the sector, but it does illustrate my point that you, the investor, need to take companies to account for outlandish forecasts of future commodity prices.

This book is for you, the commodity producer.

As a current or prospective commodity producer, you want to attract investors to your business but it’s important to spell out all of the risks involved. This book includes many recommendations for how you can do that. What questions should you be asking of the consultants that you’ve employed? How can you set the standard for the companies operating in the resource sector?

This book is for you, the consumer of commodities.

While your pension fund might have taken a hit, the average worker – you and me – now enjoy lower prices or at least ones that are not rising. However when the next boom in commodity prices comes (and it will – that is one forecast I can make), you, the consumer, will face rising costs and increasing fears over the supply of the materials that make your life and your business the way it is.

And this book is for government too.

Given the historical relationship between commodity prices and macroeconomic fluctuations, forward-looking policymakers and researchers have long been interested in predicting commodity price movements. Policymaking involves many considerations other than just price – security of supply, for example. Future taxpayers will not thank you if you’ve trapped them into paying high energy prices, way above the market rate, for long into the future. The incentives of government may be different, but that doesn’t mean you shouldn’t ask the difficult questions regarding the future risks to commodity prices.

I also hope that this book will be a spur to change.

Trust in “experts” of all sorts has been eroded in recent years, and before trust can be restored we sometimes need to look to ourselves to make marginal or more fundamental improvements. Despite being studied by some of the highest-paid analysts on Earth, commodity markets confound with maddening regularity.

It is amusing to poke fun at the experts when their forecasts fail. It’s easy for a book about forecasts to say look at so and so’s forecast and, here, look how wrong it is. And there will be some of that in this book. However, lets be careful with our schadenfreude. To say our forecasts are better than the experts’ is to damn ourselves with some faint praise. However, we can all do better, improving our own forecasts while also holding the pundits to account.

Forecasters are often likened to a car, being driven by a local with knowledge of an isolated winding road smothered in fog. The driver is being followed by others at a safe distance; the lead driver signalling to those behind where the twists and turns in the road are so that followers don’t crash into a tree or fall over a cliff.

I think this is an interesting if flawed analogy. How do you know the driver in front knows what he is doing? Will you, like sheep, just follow him over the same said cliff? The analogy also implies that commodity forecasters have some kind of omnipotent power to see ahead and prevent one or another market from teetering too far away from its fundamentals. Commodity markets and the track record of forecasters suggest that this is not the case. As with following a car in the fog, don’t just follow commodity forecasts blindly. The experience of the farmers in New Zealand shows that the outlook for commodity prices is more than just an academic interest – it has real consequences.

This book will help you understand the challenges and biases facing the commodity forecaster and, therefore, it will help you ask better questions to bring them to account.

Above all, I hope this book will help you make better decisions. Better decisions on what investments to make. Better decisions on what crop to farm. Better decisions on how to get the best deal for your business.

Want to read more? You can read the first chapter by clicking here.