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Hog Price Forecast Errors in the last 10 and 15 Years: University, Futures, and Seasonal Index

by 5m Editor
29 August 2005, at 12:00am

By John Lawrence & Priscila Aguiar, Iowa Farm Outlook, University of Iowa - One of the main goals of livestock price forecasts is to reduce the risk associated with decisions that producers make. Thus, the producers need instruments that decrease or at least identify the risk, and help the producer’s decision.

Iowa State University and other Land Grant institutions often forecast commodity prices. They use information from USDA reports, historical relationships between supplies and price, and incorporate current market conditions to a forecast of what prices may be in the future. The Lean Hog Futures is a single location where anyone with an opinion on what prices will be in the future can essentially vote their forecast by taking a position in the market. The resulting futures prices represent a “composite” forecast at a particular point in time. Finally, because hog prices follow a fairly predictable seasonal pattern the current price coupled with this historical relationship can be used to forecast prices.

Table 1 summarizes the three forecasting methods described above for the 1995-2004 period. The same day of each quarterly Hogs and Pigs report, ISU Economists forecast prices four quarters into the future and published those in the ISU Iowa Farm Outlook Newsletter. The Futures market forecast was evaluated by using the closing futures price one week after the Hogs and Pigs report was released and was adjusted for the previous 3-year average basis. A price was forecast for each month and the three months were averaged into the quarter. The 10-year average Seasonal Index was based on the monthly average price for the same month as the report (i.e., December average price following the December report) to forecast a price for each of the next 12 months and then averaged into quarters. These forecasts were then compared to the actual average Iowa Barrow and gilt price of the first quarter 1995 through the fourth quarter 2004.

Results

The forecast error was defined as the actual price minus the forecast price. A positive error means the forecast was too low. A negative number means the forecast was too high. On average all three forecasts work pretty well for the four quarters, demonstrating average errors varying from $-0.67/cwt to $0.75/cwt. The variability of the forecast is measured by additional the standard deviation and the extreme misses. We can see that variability increases with each quarter and all three forecasts are fairly similar in accuracy. Approximately 68% of the errors are expected to be within plus or minus one standard deviation from the average in the middle of the price range. There is a 16% chance of higher and 16% chance of errors lower price. An example of the standard deviation is that there is about a 68% chance that prices one quarter out will range from $4.86/cwt below the ISU forecast to $4.86/cwt above the ISU forecast (Table 1).

With the exception of one quarter out Futures and Seasonal Index forecasts tended to be lower than what actually occurred. However, the bias was quiet small two quarters out. ISU and Futures had slightly lower variability than the Seasonal Index. Table 1 – Summary of Live Hog Price Forecasting Errors ($/cwt), ISU Iowa Farm Outlook, Futures with Three-year Basis, and Ten-year Seasonal Index during the last 10 years (1995-2004).


Perhaps most informative for producers is to appreciate how much variability there is associated with a forecast. The standard deviation of the most accurate forecast one quarter out indicates that prices are expected to fall into a $7.28 range (+ and – one standard deviation) approximately 68% of the time. When one looks four quarters into the future, the time necessary to make breeding decisions, the 68% range grows to over $18.50/cwt. To put it another way, if prices four quarters out are forecast to be $45, there is a 16% chance they could be (45-9.28=) $35.72 or lower, and a 16% chance they could be (45+9.28=) 54.28 or higher.

While some may discard forecast altogether because of the wide range, the value is in helping to quantify how low prices could be. Producers then can use price protection if the forecast indicates an unacceptable risk.

In Table 2 there is a comparison between the last 15 years divided in two periods, one from 1991 to 1997 and another one from 1998 to 2004. That table can provide us an idea of how the forecasts are behaving and if our forecasting tools are still effective.

Comparing across the two time periods we can see that the standard deviation is wider in 1998-2004 than 1991-1997 for all three forecasts. Keep in mind that there were two large market surprises during the later period. First, 1998 prices were much lower than were forecast. Second, 2004 prices were much higher than forecast. While few complained about the 2004 error, it still adds to variability.

Table 2 – Summary of Hog Price Forecasting Errors ($/cwt), ISU Iowa Farm Outlook, Futures with Three-year Basis, and Ten-year Seasonal Index (1991-1997 and 1998-2004).


Table 3 summarizes the average of forecast by month for the last 15 years, 1990 to 2004 by month of forecast. On average all three forecasts work pretty well for January, April and October. July however had the highest average forecast errors. In the same way that occurred in the other forecasts, the standard deviation increased with each quarter, increasing the variability of the forecast.

The January forecast was the best one quarter average out and the worst two quarters out. In the April forecast the same happens, one quarter out is the best forecast, but the worst is four quarter out. In July, the most consistently accurate forecast is forecast two quarters into the future, and the most variant is the fourth quarter. In October, the best forecast is two quarters out, and the worst, is three. These show us that the forecasts using the two first quarters are more accurate.

Table 3 – Summary of Live Hog Price Forecasting Errors ($/cwt), ISU Iowa Farm Outlook, Futures with Three-year Basis, and Ten-year Seasonal Index during the last 15 years (1991-2004).

Summary

The forecasting methods were compared for hog prices. Basis adjusted futures then to over estimate prices one quarter out and under estimate them three and four quarters out. The ISU Extension forecast had a slightly smaller average error, but a larger standard deviation one and two quarters out. The study shows that forecast errors can be quite large. Perhaps the greater value is to use the information to quantify the risk of low prices.

Source: FarmDoc - August 2005