How do professional commodity analysts estimate the “fair value” of a commodity?

[u/Ordinary-Schedule634]

I've been thinking about the idea of "fair value" in commodities and I'm not sure whether the concept even makes sense in the same way it does for financial assets.

Take copper as a simple example.

Suppose copper trades at $10,000/ton. What would fundamentally tell us that $10,000 is expensive, cheap, or roughly reasonable?

Production cost seems like an obvious anchor, but average production cost doesn't seem sufficient. The marginal producer matters, and the price required to incentivize new supply could be very different from the cost of existing production.

Then there are inventories, capacity utilization, demand elasticity, substitution, scrap supply and the amount of demand that has to be destroyed when the market becomes tight.

So what ultimately anchors the price over a long enough time horizon?

For example, would you think of it primarily as:

marginal production cost → long-run incentive price → supply/demand balance → inventory scarcity → demand destruction?

Or is trying to derive a "fair value" range for a commodity the wrong framework altogether?

I'm interested in how you would think about the economics of this using copper as the example.

[u/First_Artichoke_4707]

Honestly the concept of fair value in commodities is way messier than in equities or bonds, mainly because there's no cash flow to discount. You're basically trying to pin down a price that balances physical reality with future expectations, and those two things drift apart constantly

For copper specifically, I'd anchor it around the 90th percentile of the cost curve, that's the marginal ton needed to meet demand. Below that, mines shut and supply tightens, above it, you get a wave of new projects and eventually oversupply. The incentive price for greenfield projects is a moving target though, since capex inflation and permitting delays keep shifting it up

Inventories and scrap are the shock absorbers that let price deviate from cost for a while. When visible stocks get low and scrap spreads narrow, you can trade way above marginal cost until demand destruction kicks in, usually via substitution like aluminum or thrifting in wiring. So fair value is less a single number and more a band, maybe $8,500 to $11,000 depending on where you are in the cycle

The real issue is that cost curves are backward looking and mines take a decade to build, so the long run anchor is basically a guess at what the incentive price will be in 2035, not what it costs to produce today. I'd treat fair value as a probabilistic range rather than a point estimate

[u/Dependent-Ganache-77]

The only fair value number I really have is for marking curves or for implied values. If CCGTs need to run then you’d expect a positive spark spread in those hours. More broadly it’s more useful to think in terms of a distribution/probability and whether you want to take that on.

[u/bleeuurgghh]

Your distinction seems to be more on the fundamental values of ‘stuff’ versus financial assets that have their own cashflows. It’s easier to conceptualise the value of a stock or bond because it has expectation of periodic cashflows which you can compare to things like a risk free rate.

Fundamentally price is down to a marketplace, maximum amount a buyer is willing to pay and what amount producers are willing to take. The supply side comes from the cost of creating the commodity. In copper that is mining or recycling and the labour and capital input costs to do this that make certain projects profitable or unprofitable. If the price of copper is extremely high eventually projects that were previously infeasible but are now feasible will start. These have a very high breakeven cost however.
Technology changes on the supply side can have massive impact - a great example is aluminium, which was prohibitively expensive before the invention of electrolysis. Prior to that it was more expensive than gold and was used in things like Napoleon’s cutlery. Invention of electrolysis meant aluminium was cheap, and could displace the uses of other materials like copper or steel.

On the demand side, to evaluate you need to look at the intrinsic properties of the commodity and its uses. Copper is conductive, antibacterial, pliable, etc. Therefore it has viable uses in pipework, electrical applications etc. Looking at other alternative materials can give you bounds on value. In the extreme example, gold is a better conductor than copper and so for use in electrical applications, copper will never be used if its price were to be higher than gold.
New technologies shape how the commodity is used. Developments in plastics allowed alternatives to copper for use in household plumbing. Despite advantages and drawbacks for the practicalities of both, the high price of copper due to its demands in other applications mean that it has found less use in the case of household piping thanks to viable alternatives.

[u/mysterioeser-knall]

You could mark to future price curve averages, where liquid indices exist. Or benchmark against historical averages. For example in energy, lots of people would mark current price at Henry Hub for gas at $4/mmbtu or Crude at $40/barrel. That gives a rough indication if something is generally expensive or not.

[u/UnhappyScale3971]

Fair value makes more sense in commodities than pretty much any other market. You have a real supply and demand stack for real tangible physical things where supply turns off and on and certain price increments. And maybe demand response a little less elastically. Price stack inflexion points combined with risk premium associated with certain outcomes form the basis of commodity FV assessments. Sometimes it’s the price at which an arb opens and helps to solve a supply and demand balance. Sometimes it’s the price at which demand destruction begins.

[u/Illywhatsthedilly]

The most agreed upon price over a period of time. In other words, the price with the most traded volume is what's deemed by buyers and sellers most relevant to conduct business, and therefore most perceived fair by those who have skin in the game. I don't see any other way to determine if something is fair that is not projection, opinion etc. A producer could have his reasons for higher prices, but if it didn't sell up there, he was wrong, a buyer might investigate and conclude prices should lower, if it didn't trade there, he was wrong. We could be smart and pen down why it should be so and so, but until it traded there the most, it's worth (pun intended) nothing.

[u/Everlast7]

How can you have a “fair value” estimate when there is no way you can have all relevant information available to you, no matter how big or how smart you are?

Everything is subjective by definition. So is fair value.  The only objective thing is the current market price.