Confidence interval for ICAC Price Forecasts
The International Cotton Advisory Committee-ICAC Secretariat issues a forecast of the season average Cotlook A Index on the first business day of each month. The forecast released on November 1, 2010 for 2010/11 (August to July) was 92 cents per pound, with a 95% confidence interval from 80 cents to 106 cents per pound.
A number of analysts have noted that the average A Index since August 1, 2010 has been more than $1 per pound, and prices would have to fall dramatically to result in a season average of 92 cents.
The ICAC model of the A Index was developed in 1988 and has gone through a number of revisions in the last two decades. The current model, developed in 2007, relates the change in the Cotlook A Index from one season to the next to the change in the ratio of ending stocks to mill use in the World-less-China during the current season, past changes in the stocks-to-mill use ratio in the World-less-China, and past changes in the stocks to use ratio in China. A fourth explanatory variable captures the impact on international prices of a domestic policy in China during the period 1991/92 to 2002/03 and 2008/09 to 2009/10.
The annual forecast is revised monthly. Each new forecast during the season for the average Cotlook A Index is a weighted average of actual prices to date, combined with the latest annual forecast for the current season.
Variables Not Accounted For
The ICAC price model does not account for government policies that could distort trade prior to the announcement of those policies, nor does the ICAC Secretariat try to anticipate the impacts of defaults on commercial contracts for the sale or purchase of cotton. Over the decades, the Secretariat has experimented with hundreds of alternative explanatory variables measuring exchange rates, inflation, economic growth, prices of complementary and competing commodities, cotton futures prices and open interest on futures contracts, and other variables.
The Secretariat has consistently found that variables “outside" the cotton market, such as macroeconomic variables, exchange rates or prices of other commodities, have no consistent correlation with season averages of the Cotlook A Index, even though such variables may seem to be significant from time to time.
ICAC Secretariat forecasts of production, consumption, stocks, trade and prices are always based exclusively on the best statistical information available to the Secretariat. Forecasts of prices are never “adjusted" based on intuition, market sentiment or at the request of governments.
In the current season, fears of defaults on contracts, threats of protectionist interventions in commodity markets by governments, and unprecedented stimulative efforts by monetary authorities, are having unpredictable impacts on cotton prices. On average over the last four decades, the ICAC price model explains about 80% of the year-to-year change in averages of the A Index.
However, by definition, records occur during years of unusual activity when past statistical relationships are of little assistance in understanding current behavior. Accordingly, the Secretariat wishes to encourage an awareness of the confidence interval around each forecast, rather than an exclusive focus on the point estimate, and the Secretariat wishes to acknowledge that in the current environment of volatility, the price model may be less relevant than in other seasons.
International Cotton Advisory Committee