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Forecasters may view a rising futures curve (a market in contango) as a sign that the market expects higher prices, and vice versa for a downward sloping futures curve. This is based on the perception that futures prices should incorporate all the available information to market participants, and that they also act as signals of what the “market” expects to happen. 

There are several factors that affect the futures curve, not just market expectations of where the price of a commodity will be. First, the physical characteristic of the commodity – whether it is easy to store and whether there are ample inventories, etc. Second, longer dated contracts are illiquid, raising doubts of whether they are an effective aggregator of information. Third, the futures curve fails to account for inflation. The fourth and final factor is that futures prices will always be discounted to the market’s expected future spot price in order to give investors a “risk premium” to take on risk from producer hedgers (known as the “normal backwardation” theory). This means that even if the spot price is estimated correctly, the traded futures price will tend to understate the market’s current real price expectations. 

Remember that commodity markets are characterised by frequent ruptures in the dominant price trend and that futures prices are of no use at all in forecasting these breaks in the trend. In addition, although some of the major commodities have well developed and liquid futures markets, this is not the case for all commodities. Nevertheless, forecasts by government institutions are likely to continue to use the futures curve. Why? It is because it is a simple and transparent market-based measure and so it is preferable to the more opaque model-based forecasts. 

Menzie Chinn and Olivier Coibion, writing in the Journal of Futures Markets, looked at the overall efficiency and predictive ability of commodity futures markets. Using data from 1990, the researchers found that overall, energy and agricultural futures prices have much better predictive capability than precious and base metals. Within the energy sector, the report found that crude futures markets do not predict subsequent price changes as well as other energy futures markets, such as natural gas and gasoline. There is a similar situation in agricultural markets, with corn and soybean futures markets found to have a much better predictive power than wheat. 

As a whole, however, the overall predictive ability of commodity futures curves has declined since the mid-2000s. Chinn and Coibion believe this may have something to do with the increased financialisation of commodity markets, which has increased the degree of co-movement in futures prices.

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