The ancient secret behind demand forecasting

By Sampo Timonen, Director, European Graphic Papers, RISI

HELSINKI, Oct. 9, 2009 (RISI) - Volatile stock markets and the latest book by Dan Brown (author of The Da Vinci Code) made me think about the short-term direction in the paper markets (...my daily job may have also had something to do with that). Forecasting the new normal level of paper demand after the largest drop in known history in 2008 and 2009 is similar to casting the dice. Demand estimates are based on GDP estimates and advertising estimates made by other people. Effect of structural changes can be maximized, minimized or neglected depending on the analyst.

You cannot see the future by looking in the rearview mirror, but something interesting can be found from history books: Leonardo of Pisa (c. 1170-c.1250), also known as Fibonacci, was one of the most talented mathematicians of the Middle Ages. He discovered that if, beginning with 0 and 1, you add the two preceding numbers to get the next number, you will end up with the following sequence: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, etc. (known as the Fibonacci sequence). Additionally, the higher up you go in the sequence, the more the figures approach the golden ratio (approximately 1.6180339887), which is widely used in Renaissance paintings (two quantities are in the golden ratio, if the ratio of the sum of the quantities to the larger one equals the ratio of the larger one to the smaller). Since then the golden ratio and the Fibonacci sequence have been found everywhere in nature, from the arrangement of leaves on a stem to the fruitlets on a pineapple.

Today technical traders in the stock markets are also using this beauty of nature. In technical analysis, Fibonacci retracement levels are created by taking two extreme points on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. These levels are used to identify possible support and resistance levels, i.e., the point where the curve will turn back. The key Fibonacci ratio (the golden ratio) is 61.8%. The 38.2% ratio is found by dividing 55 by 144 = 0.3819 and the 23.6% ratio is found by dividing 34 by 144 and so on. These ratios work surprisingly well in the stock markets and are used to find the points where a stock price will turn up or down. My theory is that too many traders believe that these ratios work and thus they put a sell (or buy) order close to the retracement levels and the actual market correlates with the Fibonacci´s findings.

But is there anything natural in the paper markets? Can ancient secrets and the golden ratio be used for forecasting the paper demand?

The drop in demand started sharply after the millennium. The crash of dot-com companies also started during the same time and pushed print advertising into free-fall. The marked turned upward two years later after a drop of 14% or 4.5 million metric tonnes on an annual level. Demand went through the 23.6% retracement level, showed some resistance at the 38.2% level, but turned downward after touching the golden ratio (61.8%). Apparent consumption swung down to the support level of 38.2%, bounced up to the resistant level at 61.8% and then turned downward again to the 38.2% level and below... easy, isn't it?

So what will happen in Europe during the next two years? We believe the bottom has been reached and the next direction is up. Since October 2007 graphic paper apparent consumption in Western Europe has declined by 25.4% or 11.1 million metric tonnes on an annual level. Based on the golden ratio the market should rebound up to the retracement level of 61.8% indicating a 9.5% (4.2 million metric tonnes) decline from the top level. I say that is the best-case scenario. Structural changes due to changing consumer behavior, the aging of the baby boomer generation, the digitalization of the world and crucial advertising mix are reflecting that the resistant level will be either 38.2% (-15.7% or 6.9 million metric tonnes) or even 23.6% (-19.5% or 8.5 million metric tonnes).

So people in the 13^th century already knew how the paper market would behave in 2010 and 2011. There is something left for the future too: the capacity in Europe is not down to the level of future demand. And by the way, the worst-case scenario is that we are not at the bottom yet.

More about Fibonacci from: http://en.wikipedia.org/wiki/Fibonacci

More about Fibonacci retracement from: http://www.investopedia.com/ask/answers/05/FibonacciRetracement.asp?&viewed=1

More about RISI's analyses from: http://www.risiinfo.com/