How Bad are Analysts at Forecasting Commodity Prices? Really Bad

Pick a mining stock, any mining stock, and there’s a very good chance that its future earnings are highly dependent on commodity prices. Rio Tinto (RIO) and Vale (VALE)? That’s iron ore. Freeport McMoRan Copper & Gold (FCX)? That’s copper. Alcoa (AA)? That’s aluminum.

Reuters

The problem: Analysts are really bad at predicting commodity prices, which inevitably leads to earnings forecasts being wrong as well. Bernstein’s Paul Gait and team explain:

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Over the last ten years, consensus has been the best at forecasting prices for aluminium, zinc and nickel and the worst at forecasting copper, iron ore, gold and silver. The average error over a 1 year time frame for aluminium has been 4%, and over a 2 year period 5%. For Zinc this is 2% and 4%, Nickel 5% and 3%. By contrast, the error on the copper forecast has averaged -7% and -19% and iron ore -8% and -21% for 1 and 2 year horizons, respectively. This suggests that a counter consensus view on aluminium, zinc and nickel prices is unlikely to be the correct course of action, while it for copper and iron ore one has to be contrarian to stand any chance of being right. In other words, the pricing dynamic of aluminium, zinc and nickel appears to be well understood while the market still finds copper and iron ore opaque.

The upshot: While “it is hard to justify a call on the value of aluminium, zinc and nickel equities based on a commodity call, while it is imperative to do so for iron ore and copper,” Gait says.

Gait believes that iron and copper stocks have the most upside, with his favorite being Rio Tinto. “To like Rio Tinto, one simply has to disbelieve that the bear scenario for iron ore prices will not play out in quite the simple way that current negative sentiment indicates,” he says. Gait, meanwhile, has concerns about the use of capital at Vale.

Shares of Rio Tinto have gained 1.6% to $52.59, while Vale has advanced 2.2% to $12.92, Freeport-McMoRan Copper & Gold has dropped 0.6% to $30.89 and Alcoa is up 0.9% to $11.94.