By Chris Berry
(Ed. Note: This is the second of two notes. In Part I we covered macro factors including the general state of various commodity markets and catalysts going forward. You can read Part I here.)
Energy Metals in Q2 and Looking Forward
Here is an overview of events associated with select energy metals along with a main driver to watch for in the second half of 2014:
Rare Earths – Though the entire sector continues to struggle from falling prices and investor disinterest, this doesn’t diminish its long-term importance to strategic sectors of the global economy. As clean tech continues to gain traction and the cost of electricity from sources such as wind and solar becomes more cost competitive, this will put a renewed focus on the strategic metals sector. While substitution is always a threat, this is far outweighed (in my opinion), by the more immediate issue of foreign dependence on critical materials. It's also important to remember that some REEs are more "substitutable" than others.
Recent pronouncements by the Fanya Metals Exchange in China tell us that this long-term view is not lost on the Chinese who are clearly intent on maintaining dominance of the global supply chain. Is the World Trade Organization (WTO) case brought by the US, EU, and Japan against China and their REE export quotas really going to shift the balance of power dramatically? I’m going to assume the answer is no.
One notable exception to this is Alaskan Governor Sean Parnell and the Alaskan state legislature who have authorized the Alaska Industrial Development Export Authority (AIDEA) to undertake due diligence and issue up to $145 million in debt to finance mine infrastructure and development costs at Ucore Rare Metals (UCU:TSXV, UURAF:OTCQX) Bokan Ridge REE project.
With the Chinese still controlling almost the entire REE value chain, I expect officials in China to continue to control the market through means other than export quotas. It remains to be seen if taxes and mine closures recently discussed will be implemented in the name of a cleaner environment (not to mention effective).
What to Watch = Molycorp's (MCP:NYSE) continued struggles and its implications for the successful establishment of a non-Chinese value chain. With a total debt load of USD $1.14 billion and trailing twelve month (TTM) interest expense $140 million coupled with TTM negative EBITDA of $140 million and negative operating cash flow of $210 million (according to Moody's), MCP is going to need to see higher prices for its products and the benefits of scale from production at Mountain Pass - soon.
Uranium – The spot and term prices fell in Q2, down 8% (21% for the year) but this cannot last as 60% of production today is below cost. Eventually, mine closures and curtailed production will match demand and a new equilibrium will be reached. The only question is “when?” I continue to believe that uranium is a 2016 story and low cost producers offer the best leverage to any increase in the uranium price.
What to Watch = Watch for deals between producers and utilities and the prices at which deals are consummated. This will bring life back into the space though I’m not terribly optimistic as excess supply is currently the name of the game.
Graphite – Talk of mine closures in China and Gigafactory buzz will continue to fan interest in natural graphite. I think synthetic graphite will be the preferred material for now, but this could change as a small number of juniors nudge closer to production. 2015 looks to be a much more exciting year for graphite than 2014. It's almost as if we've forgotten that there are numerous other avenues of demand for graphite which are growing. Graphite is about much more than just batteries.
What to Watch = An offtake agreement between a North American-based end user - not a Chinese SOE - and a near-term producer would be truly significant as it would prove the need and viability of a fully non-Chinese graphite supply chain.
Lithium – TSLA has really saved the day for lithium in 2014. Most of the junior plays were languishing along with much of the TSXV. TSLA’s Gigafactory announcement and commitment to not enforce patents around its Supercharger technology are the major outcomes in the lithium space YTD. Also interesting is the move by the Chilean government to mandate development of lithium assets in the country, though this has been discussed before.
I still view the lithium market as an oligopoly, so finding those opportunities that can exist in this environment (either through low cost production or a disruptive technological advantage) is a must. In case you missed it, I discussed what I think a lithium junior needs to do to survive and thrive in an interview with Investing News Network here.
What to Watch = Can majors continue lithium production at current rates? What are their expansion plans? Will adverse weather hamper these plans? This may be an opening for juniors. Pay attention to quarterly earnings calls next month and any published financials from SQM, ROC, and FMC.
What I'm Watching
My preferred energy metals are still scandium, cobalt, and titanium dioxide. I have discussed these ideas in previous notes, but for our new subscribers, you can read more here, here, here, and here.
It is important to remember that each of these metals have their own supply and demand dynamic and should be assessed individually. Going forward I expect performance of all energy metals (and by extension performance of share prices) to be dictated by true supply and demand dynamics rather than the parabolic boom and bust cycles we've seen in recent years. The global excesses of labor, capital, and liquidity will ensure this. This is a good development but will require patience on the part of the investor.
Despite the dour tone of this note, it is important to remember that the global economy is still expanding and there are huge sums of money going towards research and development of sustainable technologies, many of which require energy metals. Our theme of more individuals living more commodity-intensive lifestyles is in tact given the numbers in the chart below. However, out strategy of selectivity remains in place for the foreseeable future given a cloudy but positive global growth scenario.
Historically, growth in energy metals has tracked GDP growth closely. Given this precedent, here is what we can expect in additional demand for select energy metals based on the IMF global growth forecast of 2.8% in 2014 and 3% in 2015:
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