GUEST POST - Sean Rakhimov on the Troubles with Forecasting

Monday, August 24, 2009

Fretting around because my Mac did not like half a cup of orange juice and its owner simply hates clunky and illogical Softmicro "technology" I am delighted that Vancouver based Sean Rakhimov, editor of SilverStrategies, offered this guest essay about the trouble with persistently correct forecasts in markets and in general life too.
I´ll let Sean speak in his own words and hope you find them as interesting as I do.

The Troubles with Forecasting
by Sean Rakhimov
Don't worry about people stealing your ideas. If your ideas are any good, you'll have to ram them down people's throats. (Howard Aiken)

We have been pondering for some time now, exactly why most forecasts (let's focus for now on those that DO pan out) fall on deaf ears. Why is it we wondered, people en masse categorically refuse to pay attention to forecasts which – should they come true - could potentially have a dramatic impact on their lives? Take for example oil prices. Pundits, such as Jim Rogers, have been predicting $150 oil for years. He said it over and over in books, articles, interviews and speeches. If you had any interest in the subject, you must have heard it. Heck, he started a fund, created an index and spent the last decade putting his money where his mouth is - quite successfully, we might add. If you had it in you to consider his take on things, you couldn’t buy more evidence that the situation merits a second look, even if your life depended on it. Yet, most people simply ignored his forecasts. Not only that, today when oil price is again below $70, complacency reigns supreme towards what's in store for oil a couple of years down the road. Whereas, chances of 500% increase in oil price in the next 10 years are at least as good or better as it going down 50%. Do you see a problem there? If so, why do we - investors, consumers and "experts" alike – concern ourselves with the downside of oil prices?

Others, equally competent, voiced concerns about a drastic increase in gas prices which, by the way, have come to pass. The effect (or lack thereof) was exactly the same: most people, including those in the know and those who should have known, and many nice and intelligent people who could figure it out on their own, and everyone in between, all brushed these forecasts aside as nuisance. They wouldn’t be bothered with things which could only change their lives completely…
George Carlin talked about it – this utter and ultimate inertia of mind regarding anything that doesn’t include a ball game, beer and food.

Mind Games
Perhaps, the answer lies in the human psyche, in that we subconsciously refuse to deal with things that don’t disturb our immediate comfort. Of course, the whole purpose of this exercise is to learn from this experience and adjust our radars to better guide us in the future.

However, these subtleties of human nature were not lost on everyone. We remember the day in 2005 when laws in the US were changed to make the process of declaring personal bankruptcy more difficult. What caught our attention at the time was that the new law was not to go into effect for another 18 months from the day it was passed. Similar tactics are employed in other areas. Adjustable rate mortgages (ARMs) come to mind. Indeed, why would anyone worry about paying double or triple the monthly mortgage payment that s/he can barely scrape up now, if it won't happen for a few more years? Note, that in the case of ARMs, the degree of certainty that monthy payments would go up was almost absolute; yet folks still chose not to think about it. On the flip side, the "low introductory rate" was the only way to saddle millions of Americans with mortgages they could not afford. There are exceptions, but they prove the rule that those who took on mortgages they couldn’t afford had to be either delusional about their financial future, reckless or dumb enough not to understand the consequences. Or they simply didn't think about it on account that it was far enough in the future that they didn’t have to. In the same way today they don't think about $10 gas and what it will do to their lives.

Back to forecasting. It seems that forecasts are doomed to be ignored no matter what and, at the same time people can't get enough of them. However, people will only listen to forecasts that shall we say, "fit their agenda" or otherwise "approve of" their lifestyle. They will have none of the talk to the contrary, or even that which materially differs from their position and thus puts their own perspective in question.

You Cannot Forecast Short Term Market Gyrations
It's virtually impossible to consistently correctly forecast short term developments (not that folks don't try since that's where the demand is), which in many ways decreases the utility of those forecasts that do come true by reducing the overall percentage of good calls. You almost have to be a fore-teller, rather than a fore-caster to be taken seriously, which is a whole different story, unworthy of wasting our time on. It is our belief that short term forecasting with few exceptions is largely inaccurate and useless to boot.
After all, for a forecast to be useful, you need to have enough time to integrate it into your thinkin and make necessary changes and/or preparations in order to position yourself to benefit should the forecast come true. More importantly, whatever you do, you want to do ON YOUR TERMS, which usually implies plenty of lead time so that there is as little disruption (and cost) as possible to your way of life.

Longer term forecasts have potentially a better rate of accuracy, but are largely ignored due to inability of people to focus on things more than six months away. In summary:
  1. It is very difficult to make consistently correct short term calls;
  2. People's attention and interest invariably focus on the short term, many try and make a lot of poor calls (think CNBC), thus giving a bad rap to the entire concept;
  3. People usually ignore forecasts that materially differ from their own outlook, no matter how credible, and eat up those that "approve of" their actions, regardless of origin;
  4. Even when you have a good short term forecast, it's rarely useful because so many of them are wrong that few act on them at all. There is also less time to act on it in order to take advantage of the call;
  5. Longer term trends which are easier to spot and act upon, are ignored because investors are too busy chasing short term gratification. The bigger picture totally escapes them despite the knowledge that the likes of Warren Buffett bet exclusively on longer term dominant trends and enjoy greater success with less hassle.
It is very easy even for a man on the street to figure out that long term gold and silver prices are going much higher. It is more difficult at any given point to predict what will happen to them in the next few weeks or months. More importantly, the utility of short term calls is largely marginal. Unless you are a trader, in which case you are reading the wrong paper, the beef is in the long term moves. Yet you will get a lot more attention discussing a 30% move in 6 months than a 500% move in the next 5 years, which is absolutely astounding.

The last bit of "conundrum" we have to confront is this: the vast majority of investors will talk a good game. They know it all and knew all along and they know someone who made "millions" in this-that-and-the-other. They know how to do it and what to do and when. They know everything. They will talk to you for six hours straight, ask a lot of interesting questions and come across as well reasoned and perfectly sane people. They simply can't make a profit. Not the type that makes a difference. Not over the longer term. Not consistently. They just want to talk about it. They want you to talk about it and they want to talk about it themselves.

Here's one thing that forecasters get wrong: they keep talking about investors. We do it too. Trouble is that in this particular cycle, investing and survival are almost perfectly aligned. Nobody was going to starve if they didn't put money in dotcom's or airlines or countless other ventures that went belly up in the not so distant past. Turns out, moving your money out of paper into hard assets is not really optional. Not in the long term and, as we established above, the short term doesn't matter. Things that are going up in price this go around – food, energy, metals, natural resources - are essential to our way of life and have the potential to be the difference between starving or not in the coming years. Hence, they are not for investors only, they are for everyone.


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