The Art of Metal Price Forecasting

Investors in the resource industry are inundated with metal price forecasts, and indeed often go out of their way to seek opinions on where metal prices are headed. Investors, the media and pretty much everybody else with even a passing interest in resource investing obsesses over metal price forecasts. Yet, does anybody ever take a moment to consider whether those projections have any value whatsoever?

A couple of years back, I referred in the newsletter to a study by global consultancy Ernst & Young which determined that, over the previous decade, analysts’ forecasts of metal prices had consistently understated future metal prices.

A recent study by the Bloomberg information service further graphically illustrates the extent to which analysts completely miss the mark in forecasting metal prices. On the enclosed chart: The upward trending line represents the actual gold price while the downward sloping lines to the right of the trend line represents three-year forecasts made in each year from 2006 to 2012. The flat line near the top represents futures prices that could be locked in by investors in 2012.

Clearly, the analysts have consistently understated the future metal prices. The two-year forecasts average about one third less than the actual price, while the third year of the forecasts averages less than half of the real price.

A particularly dubious feature about the consensus estimates for every forecast (with one exception) is that the forecasters simply take the current price and drop it year-by-year into the future. One has to wonder how much, if any, thought goes into preparing those forecasts.

These figures are especially surprising in that the 2012 forecast points to a price that is 15% lower than the futures price.

 

These forecasts are even more inaccurate than demonstrated in this chart: typically, the third-year of the forecast is extended as a long term price forecast.

The Bloomberg analysis evaluates the forecasts from the analyst community, being mostly those associated with brokerage firms. There is a whole other set of commentators on the gold market who were not part of the Bloomberg study. I am thinking of speakers at investment conferences going back a decade ago talking about gold imminently reaching $2000, $5000 and even $30,000 an ounce.

 

Well, gold did almost reach $2000… It just took a decade longer than those forecasters anticipated. While the forecasts have moderated somewhat, there is still a tendency for some commentators to make rather exuberant forecasts for bullion.

The reality is that gold has increased in each of the past 12 years, posting an average annual gain of 17%. Few other asset classes can boast a return of that magnitude over that length of time. A simple buy-and-hold strategy for gold over the past decade would have generated better returns than earned by the vast majority of professional money managers.

In spite of that sterling return for gold, the analysts who influence investment decisions for many institutional investors consistently undervalue gold assets. As a result of those bad forecasts, emerging market investors are able to offer twice the price that North American investors are willing to pay, as happened late last year with two of the companies that we follow in Resource Opportunities. History will show that both of those investors, in spite of the big premiums, acquired gold assets at exceptionally low prices.

Gold commentators with overly exuberant forecasts are similarly distorting the market. First, those outlandish forecasts undermine the credibility of the entire gold industry. Secondly, some investors believe the forecasts, investing in pretty much any company that has gold in its name, with the dream of instant riches, yet suffering disastrous results.

A far more profitable alternative is to see the gold market for what it is: 12 years of steady gains, with an average increase of 17%. With that reality underpinning a market outlook, we can turn our attention to those specific companies that are most likely to increase in value as gold trends higher.

By far, the most profitable investment strategy is to own companies which have ounces of gold in the ground, but most importantly, deposits that will gain in value as the companies advance them toward production. The ideal exit strategy is the sale of the company to a larger gold producer, a situation that will be repeated many times over in the coming year. This approach gives us long term exposure to the gold market with the added benefit of owning companies which can provide further gains as the projects evolve.