A note published by an analyst at Barclays bank recently and reported by Fairfax media told investors that commodity prices could collapse in coming weeks as investors liquidate their holdings.
Analyst Kevin Norrish wrote that the recent improvement in the value of commodities like copper and oil does not appear to be based on changing market fundamentals. He posits that there could be a rush to the exits that would depress prices as investors seek to lock in gains and exit a sector that is unlikely to outperform for a second straight quarter. According to Fairfax reportage, copper could well lose 20% of its value from here, while oil could fall back to around US$30 per barrel.
Iron ore's decline has already begun, as a strong rally to above US$60 per tonne, unravelled in recent days.
Making an assumption of where commodity prices will be in the coming months and years is key for investors looking to purchase shares in companies like BHP Billiton Limited (ASX: BHP), Fortescue Metals Group Limited (ASX: FMG), Newcrest Mining Limited (ASX: NCM) and oil or gas producers like Woodside Petroleum Limited (ASX: WPL).
Unfortunately, while the media is diligent in covering various price predictions from a wide range of sources, it's not always clear what kind of time-frame the sources are taking. The Barclays example, reported above, is looking over the next three months or so. As a result, that prediction might not be particularly valuable to investors taking a long-term view.
One school of thought that can be particularly dangerous to investors is expecting that prices will revert to the average of what they have been over much of the past decade – which saw oil and iron ore at around US$100 per barrel/tonne. However, over a longer time frame the average prices for oil and iron ore have been substantially below this level.
Investors must take into account the 'macro' factors (such as supply and demand, and the economic situation of major customers such as China or the US) when forming their expectation of where prices will be. Then, they should take into account company specific factors, such as its marginal cost of production, where it sits within the cost curve (more or less expensive than competitors?), level of debt, potential for expansion or for mothballing (if necessary to reduce costs), and so on before considering an investment.
Perhaps more than anything, investors should prepare for continued volatility.
