Schwager on Futures: Fundamental Analysis
Summary
Jack Schwager wrote this as one volume of a three-part series on futures, covering fundamental analysis of commodity markets. It is a large technical treatment aimed at professional analysts and serious traders.
The framework is supply and demand balance analysis. Schwager sets out how to construct a balance table for a commodity, tracking beginning stocks, production, imports, consumption, exports and ending stocks, and how the stocks-to-use ratio relates to price. He covers the specific data sources and their release schedules, government reports and their reliability, and the problems of revision. He treats the relationship between cash and futures prices, the carrying charge structure and what backwardation and contango indicate about physical scarcity.
The second part covers econometric modelling of commodity prices: regression specification, the problems of multicollinearity and serial correlation, the construction of forecasting models, and the sober assessment of how well such models perform out of sample. Schwager is honest that fundamental models frequently fail and explains why, including structural change and the difference between forecasting a variable and forecasting a price that already incorporates the market's own forecast. The third part covers individual markets, including grains, livestock, energy, metals and softs, with the specific supply and demand structure of each. The market-specific material is dated but the analytical framework and the treatment of why models fail remain useful.
Key takeaways 7
- Commodity prices respond to the stocks-to-use ratio rather than to production or consumption levels separately.
- A fundamental forecast is only tradeable when it differs from what the price already reflects, which most analysts fail to check.
- The carrying charge structure of a futures curve carries information about physical scarcity that the flat price does not.
- Government supply and demand reports are revised substantially, so trading models built on initial estimates are built on noise.
- Econometric commodity models fail out of sample most often because of structural change in the underlying market.
- Each commodity has a distinct supply and demand structure, and general commodity analysis is therefore of limited use.
- Schwager argues that the value of fundamental analysis lies in identifying situations of extreme imbalance rather than in continuous forecasting.
Who should read it
Commodity analysts and futures traders who want a systematic treatment of balance-sheet analysis and an honest account of why fundamental models fail.
About Jack D. Schwager
Futures research director and author; co-founder of FundSeeder; creator of the Market Wizards series
The Market Wizards interviews are a primary record of how top traders actually operate, cited across the field.
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