Implicit in any forecast of commodity prices is an assumption of how technology could evolve and how its adoption will affect commodity prices. Commodity prices provide the incentive for new technology, yet also influence commodity production and consumption. Innovations, once introduced, may lead to higher yields from agriculture, more oil being extracted from offshore wells and deeper mines to extract more metals and minerals – all of which could eventually lead to rising commodity supplies.
High commodity prices may also lead to innovation on the demand side too. High energy prices, for example, may discourage consumers from using a particular energy inefficient product. This acts as an incentive for companies to redesign their products to become more energy efficient and less resource intensive. However, just because a technology might appear to be negative for demand doesn’t mean it has to be bad for prices, at least not in the short to medium term. For example, if oil producers are worried about the growth in electric vehicles they may decide to postpone large scale, multi-decade, multi-billion dollar investments. If they get it wrong and electric vehicles don’t take off as fast as they expect, then oil prices may rise sharply if there isn’t enough supply to meet demand.
And remember, don’t forget about rebound effects. If an innovation results in a energy intensive product (transportation for example) becoming cheaper or more accessible consumers are likely to want to consume more of it. Every improvement in technology has a rebound effect.
It’s the uncertainty over how current technology can be utilised and how technology could evolve that makes forecasting so difficult. Technological developments of all sorts involve a large dose of serendipity. The philosopher Karl Popper perhaps best describes the struggle to anticipate future innovations: “The course of human history is strongly influenced by the growth of human knowledge.” Popper also wrote:
But it’s impossible to “predict”, by rational or scientific methods, the future growth of our scientific knowledge because doing so would require us to know that future knowledge and, if we did, it would be present knowledge, not future knowledge.
Yet to forecast the price of oil, lead or cobalt into the next decade we need to make some assumption about how technology will make it easier to extract these commodities and how technology will change the demand for these commodities. Note that no one predicted the invention of pig iron or imagined how it would affect the nickel market, neither did anyone anticipate the introduction of hydraulic fracking and how it would turn the market for oil on its head.
Some commodity markets are tiny in comparison to the more conventional markets like oil, copper and iron ore. Minor metals for example include tungsten, indium, rare earth metals (REM) as well as a multitude of others with complex, exotic names. Unlike larger commodity markets, these metals are typically mined on a small scale and/or their production is a by-product of other much larger mining deposits. Macro-forces like urbanisation, consumer adoption of technology and the decarbonisation of economies are bringing many of these minor metals to the fore, as business models are re-shaped around a more sustainable and circular form of economic growth.
The opaqueness of these markets means that they are particularly prone to speculative excess. The apparent unpredictability of future technological innovations (just think how mobile phones have developed over the past ten years) creates a problem for mining executives trying to match supply of minerals with anticipated demand many years into the future. The allure of many of the mining companies operating in this area is that the pace of innovation and therefore our demand for minor metals (such as REMs, lithium and cobalt) could increase at a much far faster pace than those planning and building mines can supply.
Meanwhile, understanding the supply of these metals is difficult to say the least because it is often hidden behind a corporate or state veil of secrecy. This can be the case for many commodities, but particularly for those minor metals that are considered to be of high geopolitical importance. For example, when one private organisation dominates the market, as Companhia Brasileira de Metalurgia e Mineração (CBMM) does for niobium (~85% of global supply), critical market data is missing to outside investors.
In addition, since most minor metals exist as by-products next to more established commodities such as copper, they don’t necessarily respond neatly to the laws of supply and demand. For example, tellurium (a metal four times scarcer in the Earth’s crust than gold) is nearly always found in copper mine waste. However, unless copper miners have supplies of easy to access tellurium-laden copper waste lying around, a higher price for tellurium doesn’t provide enough incentive for copper producers to produce more of it. Due to the high cost of separating these minor metals from other commodities, prices often need to cross a certain threshold to encourage a new and more expensive method of production – this results in a kind of stepped cost curve, where supply only responds if prices rise sharply enough.
One person that is at the forefront of this trend is Chris Berry, founder of House Mountain Partners. Chris focuses on those minor metals that are essential to powering the economies of the future, those that enable the generation of renewable energy, its storage and its use in applications like electric vehicles.
When I interviewed Chris for my book, he explained that the biggest challenge facing investors in minor metals like lithium, cobalt and graphite is that their supply chains are just so much more complex than more conventional commodities:
These markets are characterized by opaque pricing structures and very demanding specifications from end users. It’s not enough to just mine lithium and produce lithium hydroxide. A mining company needs to do this in addition to securing binding off-take agreements which specify price and quantity for a specific length of time. Each section of the supply chain (mining, chemical conversion, end uses such as batteries or aerospace) is an investment opportunity in and of itself.
As an investor, you also need to factor in what the potential substitutes are (if any) and whether, just like for producers, there is a particular price point at which manufacturers also say enough is enough, we need to look for substitutes or reduce the amount of this metal in our product. The rapidly evolving technological innovation in batteries, for example, makes this particularly challenging.
The markets are small, pricing is opaque and can vary widely, and as technology continues to evolve, it becomes difficult to accurately forecast demand as it could increase or decrease for certain metals. As an example, there is a big move among battery scientists to remove cobalt from various lithium ion chemistries. This has been accomplished at bench scale, but typically when you remove or substitute one raw material in an end use, you end up using more of another. As cobalt use decreases in certain lithium ion chemistries, more nickel is typically required. How this affects economics really needs to be examined on a case by case basis.
Chris admits, though, that forecasting the price of these minor metals is little better than guesswork, which can potentially have costly implications for investors who are taken in by the narrative of ever-rising prices:
Stockpiles, recycling, scrap, new products, and geopolitical tumult are some of the main issues that need to be factored in when forecasting prices for metals and equities. While discounted cash flow models (DCFs) are a widely used tool to determine valuations, I happen to think they’re almost totally useless for most resource equities. This is especially true for assets such as resource deposits that have no operating history and hence no history of revenue, cash flow generation, or operating income. There are just way too many assumptions being made to reliably forecast prices or asset valuations.
This article is based on an extract from my recent book, Crude Forecasts: Predictions, Pundits & Profits In The Commodity Casino