CAN SPECULATORS FORECAST PRICES?

In one of the earliest studies attempting to appraise the relative ability of different trader
types in forecasting prices (Can Speculators Forecast Prices? 1957), H. S. Houthakker
assumed that the more accurately price changes were forecasted, the less they would
fluctuate, and the easier it would be for affected parties to adjust.

In 1957, Houthakker conducted a study to understand the role of speculators by
measuring their ability to forecast prices in the commodity futures markets. Using end-ofmonth
positions from the Commitments of Traders annual reports, and average monthly
prices for three agricultural commodities between 1937 and 1952, Houthakker estimatesthe profitability of large hedgers, large speculators, and small traders. To estimate profits
and losses, he assumes that the market positions existing at the end of each month were
opened at the average price during that month, and subsequently closed at the average
price for the month following. Commission and slippage costs are ignored.

In all three commodities, Houthakker calculates that large hedgers were net losers,
while large speculators enjoyed net gains for the period. (Note that I will be using
the term “large speculators,” for these older studies, since this category was, until
the 1980s, composed primarily of individual traders and not commodity funds or
pools.) Houthakker finds that small traders were profitable in cotton, but they were
net losers in both corn and wheat. In addition to being profitable overall, large speculators
were consistently profitable. They made a net profit in cotton for every year
observed. Although in corn and wheat there were a few losing years, none showed a
large loss.

Results were analyzed at a more granular level in order to isolate profits attributable
to forecasting skill, from any resulting from backwardation (Keynes’s Theory).
Houthakker finds that large speculators show definite evidence of forecasting skill, both
in the long and the short run. The experience of the small trader category indicates that
they do quite well when they stick to the long side, where sustained periods of backwardation
assure them profits. He concludes that small traders show no evidence of ability
in forecasting short-run price movements, though.