Prediction of resources market index using a scientific process - an update · 2014-10-30 ·...

Prediction of resources market index using a scientific process - an update

Presentation to the Mining Resources 2014 Conference

Noll Moriarty

B.Sc(Hons), M.Sc(Hons), Dip.Ed, Dip. Financial Services, CFP®

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XJR 200 Resources Index: 2000 - 2013

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2000 2002 2004 2006 2008 2010 2012 2014 2016

Logarithmic scale

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In mid 2013, given the negativity about Australian and world economies, many commentators and investors

expected resources sell-off to continue for some years

2 Archimedes Financial Planning Pty Ltd: presentation to Mining 2014 Conference by Noll Moriarty

Common expectation (extrapolate the existing trend)

XJR 200 Resources: 2-year Prediction

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2000 2002 2004 2006 2008 2010 2012 2014 2016

Logarithmic scale

On balance of probabilities, we predicted a turning point in 2014 • 2-year prediction ranges/probability since mid 2013 • results to-date are consistent with probability

10% chance this result or better

50% probability

10% chance this result, or worse


Archimedes’ prediction at Mining 2013 Conference

Actual result

Important note: probabilistic range based on a scientific process that predicted an

upward turning point in 2014-15

Why use a Scientific Prediction Methodology?


• No-one consistently picks major turning points in markets • Most investors have inflated views of their own capabilities

Cause - Irrational investors: – buy high and sell low – prone to overconfidence – exhibit confirmation bias (= blind to contradictory views) – incorrect understanding of timing of major turning points

Better to use a rational predictive process l let the data do the talking

During 1994 - 2013, the average US investor

underperformed the market. Source: Dalbar 2014 QAIB Press Release

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1980 1985 1990 1995 2000 2005 2010 2015

Source: Reserve Bank of Australia statistical table F07

What should you conclude from this chart - large downturn since 2008?

XJR: ASX 200 Resources Index

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1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

Source: Reserve Bank of Australia statistical table F07


Trend

Logarithmic scale

Answer: conclude nothing! It is plotted with a linear valuation scale, which over emphasises recent values, under emphasises older values

Now plotted with logarithmic scale - only scale to use with a compounding data series. It shows the valuation above/below trend clearly

Current downturn to be expected

Hypothesis: Economy controls Resources Performance?

Chart shows XJR return 12 months after a given rolling annual GDP

Source GDP: Reserve Bank of Australia statistical table G10

Observation: current health of economy is NOT a reliable guide to next 12 months resources market returns!

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-4% -2% 0% 2% 4% 6% 8%

XJR

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Rolling Annual GDP since 1980

Economists’ prediction


Australian GDP & Resources Index Return

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-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%

XJR

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Rolling Annual GDP since 1980

Chart shows XJR return 6 months before a given rolling annual GDP

Source GDP: Reserve Bank of Australia statistical table G10

Current resources return is NOT reliable guide to economic health!


Introducing Econophysics


Econophysics is scientific study of economics and finance, finding the signal in a noisy data series.

Econophysics emphasizes the positive feed backs that drive markets away from equilibrium that cause tumultuous crashes and other crises. Physics has proven tool kit to predict turning points with a rational probability. See http://physicsoffinance.blogspot.com.au/2013/05/what-haseconophysics-achieved.html

http://physicsoffinance.blogspot.com.au/2013/05/what-haseconophysics-achieved.html





Scientific Prediction using Mean Reversion


Mean reversion is the theory that interest rates, stock prices, various economic indicators, etc over time oscillate around their long-term average.

This should not be confused with charting or

Econometrics – both are mathematically flawed

Econophysical techniques use stable mathematical processes to forecast turning points, with an associated probability:

http://www.er.ethz.ch/fco; http://www.er.ethz.ch/fco

http://www.er.ethz.ch/fco

http://www.er.ethz.ch/fco

Resources Returns: Bust to Boom to Bust... ad infinitum

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1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

XJR 200 Rolling Annual Return

~ every 4 years, resources cycle through boom/bust/boom. This statistical behaviour allows rational Econophysical predictions.


Resources Returns: Bust to Boom to Bust, ad infinitum

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1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

XJR 200 Rolling Annual Return

Mean Reversion & subsequent overshooting: when valuation well above (below) mean, returns fall (rise)

(equivalent to oscillating around the mean)

Mean

-1 SD

+1 SD


Mean Reversion in Action When resources return is 1 standard deviation below mean,

what happens in the next 2 years?

Mean reversion occurs: 50% probability of +20% gain

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0 mth 6 mth 1 yr 1.5 yr 2 yr

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XJR 200 Resources: 2-year Prediction

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2000 2002 2004 2006 2008 2010 2012 2014 2016

Logarithmic scale

Resources Price Index probabilistic range: • 2-year prediction ranges since mid 2013 • results to-date • predicted upturn continues into 2015

10% chance this result or better

50% probability

10% chance this result, or worse


Important note: probabilistic range based on a scientific process that predicted an

upward turning point in 2014-15

Summary


Need logarithmic scale to see trends

Resources Index has mean reversion

Economic health is not reliable predictor

Rationally derived probabilistic prediction

Summary: Remove emotions & use a scientific approach!

• Most forecasting techniques not scientifically rigorous, often wrong

• ASX resources returns are not reliably related to economic health

• physics has tool kit to handle complex non-linear systems (such as sharemarket movements)

• remove emotions – use a scientific approach!


Main message: predicted 2015 resources returns are brighter than many people expect – not tied to economy!!

Econophysics techniques should also be applied to personal finances to determine best times to buy & sell

• specialist in advice to white-collar professionals, DIY super trustees • privately owned Australian Financial Services Licence • scientifically-based holistic advice since year 2000 • clients located throughout Australia and the world

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Prediction of resources market index using a scientific process - an update · 2014-10-30 ·...

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