How Good are Metal Price Forecasts Anyway?

Andrew McDonald

Principal Engineer, SRK Consulting (South Africa) (Pty) Ltd

amacdonald@srk.co.za

A key component in any cash flow analysis is the metal price forecast that is used. It is
important to use an independent metal price forecast, which is typically provided by
economic research divisions of investment banks and financial institutions, market
specialists, specialist subscriber-based websites or consensus market forecasts. The paper will
examine metal price forecasts from such sources for a number of different commodities over
the past 15 years and compare these to what the actual metal prices were during this same
period. This will highlight the inherent uncertainties in any metal price forecast and
emphasize the importance of sensitivity analyses on cash flow outputs. Some important
conclusions regarding mineral asset valuation will be presented.

INTRODUCTION

Cash flow models are used at various stages of the project development cycle, from concept stage, to
determine whether the project is worth pursuing, to feasibility study to support external financing. The
Cash Flow Approach is one of the three generally accepted approaches to Mineral Asset Valuation
(SAMVAL Code, 2009), and requires ‘determination of the present value of future cash flows over the
useful life of the Mineral Asset’.

The revenue line in such a cash flow model is derived from a number of techno-economic parameters
(TEPs), which at minimum include:

• Run of mine (RoM) ore mined and fed to the processing plant;
• The contained metal in the plant feed, which is derived from the RoM ore tonnes and grade;
• The processing plant recovery; and
• The forecast metal price and exchange rate (if not reporting in US Dollars).

Key components in any financial cash flow evaluation are the macro-economic projections, which include
the forecast metal price(s) and exchange rate(s).

The forecast metal prices and exchange rates can be obtained from a number of sources, such as:

• Market specialists or analysts;

• Specialist subscriber-based websites;
• Economic research companies (e.g. CRU Group, Steve Forrest and Associates, Platts a division of
McGraw Hill Financial);
• Economic research departments of investment banks and financial institutions;
• Company economic / corporate finance departments;
• Consensus market forecasts from companies such as Reuters and Bloomberg.

Whenever an independent opinion is required on value or the economic merits of a project or operation, it
is essential that the metal price and exchange rate forecasts are obtained from an independent source. This
adds credibility to the forecasts used and resultant value derived, and avoids any bias or subjectivity that
may arise from in-house derived forecasts.

For certain commodities such as ferroalloys, the number of sources for metal price forecasts is limited. By
contrast, for common commodities (gold (Au), copper (Cu) and platinum (Pt)), it is possible to get forecast
prices from as many as twenty separate sources. Inspection of these forecasts usually shows considerable
variability – this is where the use of consensus (or average) price forecasts comes in (see the example in
Table I of Cu price forecasts in early 2006 from a number of investment banks such as RBC Capital,
Merryll Lynch and Deutsche Bank).

Table I. Example of variability in forecast Cu prices in USD/lb from a number of investment banks.

Source 2006 2007 2008 2009 2010 2011 2012

Bank 1 1.85 1.40 1.60
Bank 2 2.30 2.50 2.00 1.80 1.50 1.50 1.50
Bank 3 1.80 1.55 1.20 1.10 0.90 0.90 0.90
Bank 4 3.06 3.25 2.30 2.00
Bank 5 3.06 2.30 1.62 1.45 1.23 1.11 1.11
Bank 6 2.00 1.75 1.40
Bank 7 1.95 1.45 1.23
Bank 8 2.05 1.66 1.38 1.25 1.15
Bank 9 2.53 2.36 2.00 1.50 1.30 1.30 1.30
Bank 10 3.37 2.04 1.27 1.13
Consensus/Average 2.40 2.03 1.60 1.46 1.22 1.20 1.20

Table I also illustrates that some investment banks are not prepared to provide forecasts beyond three to
four years into the future, whereas others will provide forecasts of up to eight years.

This paper examines the metal price forecasts from various sources for a number of different commodities
over the past 15 years and compares them to what the actual metal prices were during this same period.
This will highlight the inherent uncertainties in any metal price forecast that may be used today and
emphasize the importance of sensitivity analyses on cash flow outputs.

HISTORICAL METAL PRICES

Figures 1 to 4 give historical metal prices for iron (Fe) ore, Au, Pt and Cu respectively. A common feature
in these graphs of historical prices is a long period of relatively stable prices, followed by a rapid increase
in the prices (the global commodity boom), price volatility (after the world financial crisis and market
uncertainty) and finally a gradual reduction in prices (market uncertainty and slowing of the Chinese
economy).

METAL PRICE FORECASTS

View in 2000
Consider the perspective of an analyst in 2000 (the blue arrows in Figures 1 to 4). Following many years of
stable prices, his forecast metal prices would largely seek to perpetuate the past, as can be seen in Figures
5 to 8. His predictions for the Fe ore price were correct in the short-term, but after 2004 fell short of what
actually happened. If this had been for a greenfields project, start of production would have occurred as
prices started to increase – the perfect situation all companies hope for but rarely achieve.
 Figure 1. Historical Fe ore price Figure 2. Historical Au Price
(source: www.indexmundi.com) (source: www.kitco.com)

Figure 3. Historical Pt Price Figure 4. Historical Cu Price

(source: www.kitco.com) (source: www.investing.com)

Figure 5. Comparison of actual and forecast Fe ore price Figure 6. Comparison of actual and forecast Au price at
at 2000 2000

Figure 7. Comparison of actual and forecast Pt price at Figure 8. Comparison of actual and forecast Cu price at
2000 2000
The actual and forecast prices in Figures 5 to 8 quickly diverge because the forecasts are based on stable
market conditions per the past, and had no way of predicting the rapid price increases that would arise
due to the commodity boom. In the examples of the Au, Pt and Cu prices (Figures 6 to 8), the variability in
forecasts from different sources can be seen.

View in 2004
Four years later, no major changes in the long-term trend of metal prices was noticeable and a similar
forecasting philosophy was maintained, albeit from a slightly higher starting point (Figures 9 to 12). The
Fe ore price projections in Figure 9 were as at 2006 rather than 2004, but still provide the same perspective.
The divergence between the actual and forecast prices is as significant as seen in 2000. The difference in
investment bank views of how the prices would perform is again evident.

Figure 9. Comparison of actual and forecast Fe ore price Figure 10. Comparison of actual and forecast Au price at
at 2006 2004

Figure 11. Comparison of actual and forecast Pt price at Figure 12. Comparison of actual and forecast Cu price at
2004 2004

View in 2008
Fast forward four years to the middle of the global financial crisis in 2008. Markets were in turmoil and
the JSE Limited All Share index shed more than 40% of its value in less than six months, from a high over
32,000 to a low around 18,000.

Three constant price scenarios were used for the evaluation of a Fe project (Figure 13) – the current price,
a long-term price (40% below the current price) and an upside price (20% above the current price). As it
turned out, none of these price scenarios was correct.

From the wide scatter of forecast Au, Cu and Pt prices (Figures 14 to 16), there were very divergent
opinions regarding how the market was going to react. The general view was a pessimistic one going
forward, as shown by the downward trend on the forecasted Au, Pt and Cu prices. While the price
projections reflected market sentiment, these were very different from what actually happened to the
prices.
 Figure 13. Comparison of actual and forecast Fe ore Figure 14. Comparison of actual and forecast Au price at
prices at 2008 2008

Figure 15. Comparison of actual and forecast Pt price at Figure 16. Comparison of actual and forecast Cu price at
2008 2008

View in 2011
Having survived the global financial crisis and been rescued by the massive interventions from the central
banks of the USA, Europe and Asia, the markets and commodity prices had recovered quite quickly.
There was however still a great deal of price volatility as the markets came to grips with conflicting
messages. From 2011/2012, the Fe, Au, Pt and Cu prices commenced a steady decline (see Figures 1 to 4),
spurred on by concerns over the Chinese economy, the conflict situations linked to the Arab Spring and
recessionary trends.

The forecast for Fe concentrate and pellets provided for reduced prices over time, but were more
optimistic than actually occurred (Figure 17). The severity of the pull-back in Fe ore prices caught
everyone by surprise.

The forecast Au price (in real terms) was initially lower and then higher than the actual price (Figure 18).

The forecast Pt price was more optimistic than what actually occurred (Figure 19). Worse, the forecast
provided for increasing real prices whereas the prices went the other way.

The forecast Cu price got the downward trend right, but was much more conservative than what actually
happened (Figure 20).
 Figure 17. Comparison of actual and forecast Fe ore Figure 18. Comparison of actual and forecast Au price at
price at 2011 2011

Figure 19. Comparison of actual and forecast Pt price at Figure 20. Comparison of actual and forecast Cu price at
2011 2011

So what changed?
So what changed so significantly that price forecasts over a decade were so wrong? Up until 2002/2003,
the market had experienced generally stable commodity prices. Up to this time, long-term trend lines
were generally reasonable for forecast prices.

The Fe ore, Au, Pt and Cu prices then deviated significantly from the long-term trends, catching everyone
by surprise. Producers had not foreseen the pent-up demand from the East, in particular China, which
outstripped supply. The minerals industry had for most of the 1980s and 1990s been in the doldrums,
with exploration budgets slashed drastically and new mining projects put on hold indefinitely.

Structural Shift in the Market?

Around 2011/2012, speculation was rife that there may have been a structural shift in the market (see
Figure 21). In other words, the supply-demand dynamics had changed such that future prices could be
supported at higher levels.

The downward movement in commodity prices (see Figures 1 to 4) then suggests that these propositions
may have been premature.
 Figure 21. Structural shift in Cu price?

OTHER CONSIDERATIONS WITH PRICE FORECASTS

Nominal vs Real
It is necessary when obtaining commodity price forecasts to confirm whether the projections are in real or
nominal terms, i.e. constant money terms at the date the forecasts are provided, or money terms at some
future date. The difference can be seen in Table II.

The real terms forecast will take into account aspects such as operating cost pressures of the primary
producers, supply and demand characteristics and other extraneous factors. The nominal terms forecast
is based on the real terms forecast, but includes the effect of inflationary pressures on the USA and the
United States Dollar (USD).

Table II. Comparison of nominal and real forecast Pt prices.

Metal Price (USD/oz) 2010 2011 2012 2013 2014 2015 2016 2017
Nominal 1,217 1,340 1,419 1,427 1,415 1,467 1,522 1,560
Real 1,202 1,291 1,334 1,309 1,266 1,281 1,296 1,296

Link to ZAR:USD Exchange Rate

With its dominance of supply of a variety of commodities and metals, South African producers can to a
certain extent be considered as price shifters, i.e. to maintain their margins with rising costs, they can
adjust the selling prices into the market and others will follow suit. Examples of such commodities are
ferrochrome (FeCr), chrome (Cr) ore and platinum group metals (PGMs).

Under these conditions, any price forecast that does not consider how the South African Rand (ZAR) will
perform against the USD only gives part of the story. It does not help either if price forecasts are obtained
from one source and forecast ZAR:USD exchange rates from a separate source – it is very likely that the
underlying assumptions and views on market supply/demand conditions are different, so the two sets of
projections are not even related.
Use of three-year trailing average price
Based on concerns raised by the British Columbia Securities Commission, American Manganese Inc. had
agreed to use a 3-year trailing average price in the evaluation of the economic feasibility of its Artillery
Peak Project (Reugh, 2012). Reugh (2012) reported that this was a more conservative price forecast than
the expected case provided by the CPM Group.

Inspection of Figure 22 shows that in a rising market, a three-year trailing average understates the price.
This illustrates the reason why the price forecast was ‘more conservative’.

Figure 22. Three-year trailing average prices

By contrast, in a falling market, a three-year trailing average will overstate the commodity price. While
this method of price forecasting is accepted, it is important to remember its limitations as described above.

Effective Date
Given the volatility in commodity prices, it is necessary to state the date at which the price forecasts and
exchange rate projections are determined. This Effective Date then prescribes that the cash flow
projections and any opinions on value in a report are only valid at that date.

It is also advisable that all other technical-economic parameters used in a cash flow evaluation are valid at
the Effective Date to be consistent with the price forecasts.

CONCLUSIONS

There were many conflicting views during late-2015 and early-2016 regarding the state of the market and
where commodity prices are headed. Mineweb.com, a subsidiary of Moneyweb Holdings Ltd, posted a
number of articles regarding views on where the gold price is headed. Levenstein (2015), Holmes (2015)
and GFMS (2015) all suggest that there are good prospects for an increase in the gold price in 2016. Gold
flows to Hong Kong and China were enormous in 2015 but these flows were not correctly reflected in the
global gold price mechanism (Levenstein, 2015; Bloomberg, 2015). During this same time, Russia,
Kazakhstan and Ukraine increased their gold reserves.

Among the gold bears, Lloyd-Smith (2015) and Biesheuvel (2015) were concerned that when the US
Federal Reserve raises interest rates this will negatively impact on the gold price. This sentiment is echoed
by Barnabas Gan of Oversea-Chinese Banking Corp in Singapore who was quoted as saying ‘higher rates
drive up the dollar, curbing gold’s appeal as an alternative’ (Roy and van der Walt, 2015).

Arendse (2015) provided some interesting views on the sophisticated and complex models used by inter
alia analysts and investment banks to forecast growth and other market factors - ‘Evidence from events
such as the dot.com bubble and the 2009 financial crisis show that you would perform just as well if you
had simply guessed.’ Rowan Williams of Nitrogen Fund Managers was quoted by Arendse (2015) as
saying ‘there are too many different opinions and it is not clear what the time horizon of the various
forecasts is.’

Yaldwyn (2015) provided an interesting view of price forecasting – he recalled someone once writing that
he had used a ‘cow in a paddock’ method to forecast the price of gold. In essence, if you had to predict
where a cow would be standing in any paddock in 12 months’ time, you would have a better chance of
getting it right if you predicted the place it was standing at the time of the prediction than any other place.
So use today’s price as next year’s guess.

Somerville (2015) recommended that a sensitivity analysis should be done using a range that matches the
annual price volatility of the commodity across a number of market cycles.

Given the uncertainty in forecast prices and exchange rates, it is unlikely that the forecasts satisfy the
±10% confidence requirements of a feasibility study for a mining project. It is therefore critical to evaluate
the sensitivity of a project to price and exchange rate fluctuations. The declared mineral reserves for a
project or mine are also affected by commodity price fluctuations and the impact of varying prices on the
reserves and cut-off grades should be similarly evaluated.

REFERENCES

Arendse, N (2015), Cut forecasters some slack, but don’t bet on accuracy either.
http://www.mineweb.com/articles-by-type/analysis/cut-the-forecasters-some-slack-but-dont-bet-on-
their-accuracy-either/ (article dated 21 October 2015, downloaded on 22 October 2015).

Biesheuvel, T (2015), Gold volatility near four-week low as prices steady before Fed.
http://www.mineweb.com/news-fast-news/gold-volatility-near-four-week-low-as-prices-steady-before-
fed/ (article dated 21 October 2015, downloaded on 22 October 2015)

Bloomberg News (2015), China gold imports climb on pre-holiday buying and lower prices,
http://www.mineweb.com/news-fast-news/china-gold-imports-climb-on-pre-holiday-buying-and-
lower-prices/ (article dated 27 October 2015, downloaded on 29 October 2015).

GFMS (ThomsonReuters) (2015), Better prospects for gold on the horizon – GFMS,
http://www.mineweb.com/articles-by-type/company-releases/better-prospects-for-gold-on-the-
horizon-gfms/ (article dated 28 October 2015, downloaded on 29 October 2015).
Holmes, F (2015), Will gold finish 2015 with a gain? http://www.mineweb.com/articles-by-
type/independent-viewpoint/will-gold-finish-2015-with-a-gain/ (article dated 20 October 2015,
downloaded on 22 October 2015).

Indexmundi (2015) Historical iron ore prices,

http://www.indexmundi.com/commodities/?commodity=iron-ore&months=300 (downloaded on 10
March 2016).
Investing.com (2016) Historical copper prices, http://www.investing.com/commodities/copper-
historical-data (downloaded on 10 March 2016).
Kitco (2016a) Historical gold prices, http://www.kitco.com/scripts/hist_charts/yearly_graphs.plx
(downloaded on 10 March 2016).
Kitco (2016b) Historical platinum prices, http://www.kitco.com/scripts/hist_charts/yearly_graphs.plx
(downloaded on 10 March 2016).
Levenstein, D (Lakeshore Trading) (2015), Gold ready to take its position when QE undoubtedly fails,
http://www.mineweb.com/articles-by-type/analysis/gold-ready-to-take-its-position-when-qe-
undoubtedly-fails/ (article dated 28 October 2015, downloaded on 29 October 2015).

Lloyd-Smith, J (Bloomberg) (2015), Goldman says Fed raising rates in December will hurt bullion.
http://www.mineweb.com/news-fast-news/goldman-says-fed-raising-rates-in-december-will-hurt-
bullion/ (article dated 22 October 2015, downloaded on 22 October 2015).

Reugh, L (American Manganese Inc) (2012), Base Case Amended to 3 Year Trailing Average After Review
by BC Securities Commission, http://www.americanmanganeseinc.com/base-case-amended-to-3-year-
trailing-average-after-review-by-bc-securities-commission/ (article dated 27 August 2012, downloaded on
30 October 2015).

Roy, D and van der Walt, E (Bloomberg) (2015), Sorry gold bulls, metal’s best forecaster expects more
declines, http://www.mineweb.com/news/gold/sorry-gold-bulls-metals-best-forecaster-expects-more-
declines/ (article dated 1 July 2015, downloaded on 29 October 2015).

SAMVAL Code (2009). The South African Code for the Reporting of Mineral Asset Valuation, 2008
Edition as amended July 2009, prepared by The South African Mineral Asset Valuation (SAMVAL)
Working Group under the auspices of the Southern African Institute for Mining and Metallurgy and the
Geological Society of South Africa.
Somerville, K (2015). Ore Reserve estimates and changes in commodity price – a survival guide, posted
December 2015 on AusIMM bulletin, www.ausimmbulletin.com/feature/ore-reserve-estimates-and-
changes-in-commodity-price-a-survival-guide (downloaded on 26 January 2016).
Yaldwyn, R (2015) personal communication.