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DecisionNext Blog

Prophesies, Oracles and omens – why you should ignore single point forecasts

Published by Bill Hart November 25, 2015

We all know that mining is cyclical, but it seems someone forgot to tell the analysts and economists who forecast prices. When prices were high, analysts were suffused with ‘irrational exuberance’ and predicted high prices forever. The industry has replaced the “stronger for longer” mantra with a deep pessimism. Perversely, now that mineral commodity prices are well down from their peaks, the common comment in the industry is “I didn’t expect such a collapse” and analysts predict yet further price falls.

We have to stop using single point projections of the recent past to justify decisions (see the oil prices forecasts below for one illustration). It’s a given that commodity prices and markets are both volatile and cyclical. Mining analysts typically present their forecasts as a series of single numbers (or even a single number). But are they any better than mythological prophecies of the past? Their forecasts are not only based on past behaviour – already a weakness – but are usually a flat line close to today’s price. The problem is that people are unpredictable, and similar situations in the past do not guarantee similar results in the future. And yet the industry and its financiers continue to put credence on these figures.

Howard Marks, an astute investor and market observer, says in his book ‘Uncommon sense for the thoughtful investor’: “It’s essential to remember that just about everything is cyclical. There’s little I’m certain of, but these things are true: Cycles always prevail eventually. Nothing goes in one direction forever…. and there’s little that’s as dangerous to health as insistence on extrapolating today’s events into the future.” He goes on to say that “You can’t predict. You can prepare ……. we never know what lies ahead, but we can prepare for the possibilities and reduce their sting.”

The problem is not so much that these forecasts are wrong (although they usually are), but that they don’t take into account the inevitability of cycles and volatility. So while it’s almost a cliché to say that markets for minerals are cyclical and volatile, each new cycle sees a new generation of executives learn the lesson over again. Thinking about cycles is different from forecasting. Understanding cycles (or being lucky with the cycles) may be the most important capability of mining executives.

Shortly Mine Insider will publish its ratings of CEOs of major mining companies in the past decade. The ratings show that share price performance for those executives smart enough or just plain lucky is all about timing the big cycles. Making the right moves at the right time including asset acquisitions, divestitures and managing costs at all points of the cycles are critical.

In the early 2000’s the China boom was just becoming apparent, but few mining companies anticipated that change or were prepared. We are now in a period where mining companies are grinding out cost improvements and incremental tonnes while share prices remain depressed. But as Howard Marks says “cycles prevail”. Is the industry ready for the next part in the cycle or are we once again acting as if today’s price will last forever?

 

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This article was originally published at Mine Insider.