Mark Twain put it best when he said:
"It's not what you don't know that gets you into trouble; it's what you know for certain that just ain't true."
This quote is often referred to by value investors as it serves as a reminder that investing is an imprecise science and involves making assumptions and forecasts which are at best just informed guesses.
An informed guess is certainly the best that can be expected when it comes to forecasting a commodity price and that is why so many value investors shy away from the resources sector – they know what they don't know!
For investors who still choose to invest in the resource sector, they run the risk of basing their company valuation on a commodity price they believe will occur when in reality it will almost certainly be different.
Currently the iron ore price is just below US$70 per tonne, however according to a report in the Australian Financial Review the government's mid-year economic and fiscal outlook is expected to forecast an annual average iron ore price of just US$60 per tonne.
While the Treasury Department's track record at forecasting is far from stellar, it highlights to investors that one of the departments with the deepest data bank of knowledge on the Australian economy is seeing no signs of a turnaround in prices.
This is bad news for all iron ore producers including the majors BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG). At US$60 per tonne the profit margin between their all-in operating costs and the sale price is much slimmer than scenarios based on higher iron ore prices.
More importantly, it's questionable whether the market has fully priced in a lower for longer scenario. Despite BHP, Rio and Fortescue all hitting new 52-week lows today they could still have further to fall.
