SHORT-TERM FORECASTS FOR COMMODITY MARKETS: LINKING MARKET DEVELOPMENTS

New FAO tool to improve market analysis

This edition of Food Outlook launches FAO’s Short-term Consistency Model (STCM). The model has been conceived as a tool to guide and strengthen FAO market analyses. STCM serves to complement and enhance the qualitative forecasts of FAO commodity analysts in several ways. First, STCM takes into explicit account the various linkages and interactions between commodity markets at the global level, and in doing so it provides for consistency in the outlook. Second, by solving for equilibrium, STCM can assess the plausibility of the forecasts. For instance, are FAO’s forecasts for trade, consumption, ending stocks and prices reasonable at the foreseen level of production? Third, the robustness of the qualitative forecasts can be gauged by imposing shocks or disturbances to selected markets and then seeing how such forecasts differ in direction and magnitude. Finally, STCM can be used as a platform to conduct short-run scenario analysis. For example, the model was recently used to examine the near-term effects on global markets of avian influenza and other animal disease outbreaks.^1/

How is STCM constructed and how does it work?

At the heart of STCM lies a set of behavioural relationships formulated to capture short-run (one-year) responses of various market agents. These relationships depict market activity for some 15 commodities in 50 countries and regions.^2/ Arguably, production is one of the leading drivers affecting the market’s outlook, particularly for the short term. From FAO’s crop and livestock assessment activities, involving missions, responses to FAO questionnaires and information obtained from other sources, production estimates are prepared and then incorporated into STCM. The latest information on exchange rates, population, income and inflation rates are other exogenous variables used in the model. The STCM has a dynamic representation, in that many of the variables are influenced by both past behaviour and time trends. For instance, since consumers in a traditional rice country consume a certain amount of rice in one year, they will not depart a long way from consuming a similar quantity the next year. The relationships constructed in STCM take into account such behavioural dynamics. In order to solve STCM, numerical optimization methods are employed to find equilibrium prices for which global demand matches global supply. In a nutshell, at these market clearing prices, short-term forecasts for trade (imports, exports), utilization and ending stocks are generated.

STCM in action: global market prospects in the short term.

The 2006 solution to STCM was provided for using the methodology described above. The results have already been used to guide the commodity contributions in this edition of FoodOutlook. However, as a stand alone tool the model predicts certain regularities which are expected to emerge in the current year:^3/

a tightening of 2006 supplies vis-à-vis 2005 for many storable commodities;

a strengthening of prices, particularly for storables, but generally lower prices for livestock products; and

a return to growth in animal feed usage and further expansion of industrial use, especially biofuel.

With the prospect of a forecast contraction in 2006 grain production, STCM predicts that wheat and coarse grain prices will rise in 2006, by 10 and 12 percent, respectively as compared with 2005, with global trade in grains changing little from the previous year. Withdrawals from grain inventories would play a pivotal role in sustaining total utilization (food, feed and industrial applications). However, supplies are predicted to become tighter with stocks declining much faster than in previous years. Regarding rice, the modest increase in global production forecast for 2006 does not seem sufficient to keep pace with total consumption predicted by the model, with prices projected to rise by 15 percent, faster than other cereals.

Forecast developments in the feed grain markets (including coarse grains) are consistent with expected rising meat production, especially pork and beef, and dairy output. Rising protein meal production and consumption (from soybean, sunflower and rapeseed) are also in line with expanding output of livestock and livestock products. Oil meal prices are expected to remain firm, despite a sharp contraction in trade, as much production is expected to be absorbed domestically.

Given the fragmentation of international meat markets, price prospects for the meat sector are rather mixed. The model predicts prices for beef and pork traded in the Pacific Rim market (where FMD is not endemic) to decline but to remain steady in the Atlantic market (the world market excluding Pacific Rim trade). Reference prices of poultry and sheep meat are forecast to fall as a result of demand contracting in the former market and excess supply in the latter. Dairy product prices are all predicted to decline, particularly for butter and cheese, which could both register falls of up to 10 percent, as production of these commodities is forecast to outstrip consumption.

What if FAO has underestimated or overestimated production outcomes?

One advantage of STCM is that it can examine the sensitivity of price developments to production uncertainties by simulating the global impact of random production shocks, both positive and negative. To bring some realism into the picture, average historical variations in production are used to condition the shocks. In other words, if a country’s production of a certain crop has only varied by 10 percent from year to year in the past, then it can be expected that it will not vary by more than this amount in the next period.

To add further meaning to the analysis, the production shocks could be restricted to those producing countries which can influence the global market, either through their imports when domestic availabilities fail to cover domestic needs, or when the country presents itself to the world as a major exporter.

Since cereal production in many of the important producing countries in the northern hemisphere is uncertain so early in the season, STCM was used to show a range of possible movements in indicative price quotations for three important cereals. Figures 32-34 show the potential movements in the indicative international prices of wheat, maize and rice markets, according to the assumptions noted above.

The scope for prices to fluctuate in 2006 is somewhat large, ranging by as much as 18 percent for maize down to approximately 10 percent for rice, with the tendency for prices to rise being more prominent than for prices to fall. A word of caution however: the range within which prices vary as depicted in the figures assumes that production variation does not go above that observed in the past. In other words, events brought about by unforeseen economic instability, socio-economic shocks, etc. are beyond the model, but this does not mean that they cannot come to pass in the remainder of the year.

 

1.  “Animal production food safety challenges in global markets”, OIE Scientific and Technical Review, vol. 25 (2), August 2006

2. Commodity and country/regional coverage mirrors the COSIMO medium-term projections framework

3. It is important to note that the following market developments, particularly the outlook for prices, refer to a period average of 12 months or the (equilibrium) outcome after one year of adjustment