Given so much uncertainty, it is pleasantly surprising to see many commodities, and the companies responsible for exploration and development of them, off to such a strong start in 2014. I have said many times before that each commodity has its own supply and demand dynamic and should be viewed in isolation. With respect to soft commodities, the weather can also play a significant role as we’ve seen with the YTD performance of coffee. According to Bloomberg, Arabica coffee futures rose 61% in Q1 2014 which is the largest quarterly gain since 1997. Much of this crop comes from southeastern Brazil, which is currently experiencing the driest summer since 1972. Remember this as you stand in line at Starbucks (SBUX) or Tim Hortons (THI) .
All that said, while I still believe in the commodity super cycle over the long term, it is clear that the wind is no longer at our backs and not all commodities and companies will outperform. The remainder of this Note focuses on a select group of metals and their fortunes YTD.
Uranium has roared ahead in Q1 on the back of the possibility of Japanese reactor restarts and a looming supply and demand imbalance in favor of increased demand. The chart below shows the Q1 returns for an equally weighted basket of uranium plays against the S&P 500 and the TSXV. We can argue about what an appropriate index is to benchmark returns here, but in Q1 it really didn’t matter as a mixture of hype and hope pushed company share prices higher than either index. I am currently skeptical as to how long this can continue, but still believe that uranium is a “contrarian’s dream” and a wise place to allocate capital through 2016 when the real supply pinch could manifest itself.
Source: Google Finance
Cameco (CCJ) ($CCO:CA) the bell weather of the uranium space, continues to consolidate and shed assets. This behavior is not unlike what we see in other sectors, most notably gold. When it ceases or CCJ becomes more acquisitive, the “turn” in uranium could be upon us. It is an unpopular position to take, but I don’t anticipate this before 2016.
In the face of a weak spot and forward price environment for U3O8, I continue to believe the low cost ISR producers offer the highest acceptable leverage to the price and sufficient safety based on near term or immediate cash flow. UR-Energy (URG) ($URE:CA) and Uranerz (URZ) ($URZ:CA) are two prime examples.
In Jan 2013, I wrote a Note stating that the most important factor to watch in this space is rare earth prices. Price risk is more important that metallurgical risk, financing risk, permitting risk, or any other risk associated with early stage REE mining ventures. Without predictable or steady prices for oxides and metals, it amplifies all of the risks mentioned above and renders most projects uneconomic. Adding complexity to this issue, many companies use a 3 year trailing average for price assumptions in PEAs, PFSs, etc. This timeframe coincides with the timing when REE prices went parabolic. I a anticipate REE prices remaining high on a historic basis, but as costs have also risen, those companies that can present a manageable operating expense are going to win. The bloodbath in REEs appears to be over, but, as with a host of other metals, the “turn” doesn’t necessarily appear to have come.
Source: Google Finance
REE plays have performed remarkably well in the face of pricing uncertainty and a lack of investor interest. The recent announcement by the World Trade Organization stating that China’s export policies for REEs was illegal should have breathed new life into the non-Chinese space and it really didn’t.
It is clear to me that investors, both retail and institutional, have their minds made up – high cap ex projects with a preponderance of light REE mineralization are not going to make it. A focus on lower cap ex (maybe $300 million and below?) projects in reliable political jurisdictions with a preponderance of heavy REE mineralization is at least a starting point. Good examples are Tasman Metals (TAS) ($TSM:CA) and Ucore Rare Metals ($UCU:CA) (UURAF) , two projects I have conducted site visits to.
Once these “boxes have been ticked”, then a focus on metallurgy, mineralogy, financeability, etc is warranted. End users have also made strides in attempting to engineer “out” REEs from their products as shown below. This is another risk investors must consider.
At the end of the day, REEs are still a crucial component of society’s technological and defense capabilities – that much won’t change. Going forward, watching the pricing trends of select REEs and also watching China’s response to the recent WTO ruling will provide the clearest indication of the way forward.
Graphite, Lithium, and Cobalt
I am linking these three together as their fortunes in Q1 were tied together by the Tesla (TSLA) announcement of the company’s Gigafactory which would potentially produce more lithium ion batteries by 2020 than are currently produced globally. I discussed this in depth in a Morning Note on March 12th titled, “What the Gigafactory Means for the Junior Miners”.
A basket of graphite names I am monitoring (soon to be updated) clearly spiked higher on the Gigafactory announcement and subsequent news of TSLA sourcing North American raw materials to supply the operation.
Source: Google Finance
Recent news of off take agreements for both Focus Graphite ($FMS:CA) (FCSMF) and Syrah Resources (SYR:ASX) (SYAAF) is a welcome development as it validates the belief that a junior mining graphite company can integrate into the global graphite supply chain. It is interesting to note, however, that both off take agreements (still to be finalized) are with Chinese companies. SYR’s Memorandum of Understanding is an agreement with Chalieco, an affiliate of Chinalco, for between 80,000 and 100,000 tonnes of flake graphite and a separate amount of vanadium pentoxide. The off take agreement FMS has signed allows for a minimum purchase of 20,000 tpy of future production from its Lac Knife deposit from an undisclosed Chinese conglomerate. These are significant amounts of material.
For the Gigafactory to become a reality, we’ll need to see TSLA enter into these types of agreements and this is why I am still optimistic on flake graphite demand and the prospects for Western graphite development plays. Interestingly, the ability to produce spherical graphite is a necessity and both SYR and Northern Graphite ($NGC:CA) (NGPHF) have successfully accomplished this.
The key will be TSLA’s ability to source flake graphite that is cost competitive with product sourced in China. TSLA currently sources its graphite from Japan. A big part of the plan to lower battery costs by 30% will involve sourcing material “close to home.” The next 12 to 18 months promise to be an exciting time for graphite.
A basket of lithium stocks (below) has performed well, though started to lose some steam in March. The oligopolistic market structure of lithium has always worried me and I think it could present problems for juniors who are looking to join the select company of lithium producers. Lithium can potentially benefit from announcements like those TSLA has made, but this is a well-supplied market and while I have no doubt that demand is forecast to increase in the future (with or without the Gigafactory), there is currently no forecast supply issue.
Source: Google Finance
Cobalt also deserves a special mention as demand should also increase (by as much as 4,000 to 5,000 tonnes) if the Gigafactory comes to fruition. A lack of pure plays in cobalt has made this a somewhat challenging sector to watch, but the success of the battery business currently depends (in part) on a reliable source of high purity cobalt. According to the LME, cobalt prices have been volatile in 2014, but have increased by over 5% YTD.
Source: Google Finance
We continue to believe in the fertilizer story and view success here as a longer-term investment proposition. China reportedly has 10% of global arable land and uses over 30% of global fertilizer. This trend and tightness in the potash and phosphate markets will continue. The basket of fertilizer names I’m tracking hasn’t performed as well as others listed above, but then again, the fertilizer markets don’t have an Elon Musk to breathe life into them. The name of the game here is security of supply and therefore a solid knowledge of end users and their needs is a must if you want to uncover those junior development stories that stand the best chance of integrating into the global supply chain.
Tin and TiO2
Tin (and by extension nickel) have performed well YTD with tin prices up over 2% and nickel posting its largest quarterly gain since 2010 of 15%. This should continue as the ore export ban in Indonesia implemented in January is still in place and doesn’t appear to be going away anytime soon. A lack of pure plays has dulled excitement here somewhat, but Metals X (MLX:ASX) (METSF) appears to be one of the biggest beneficiaries of a higher tin price going forward. I have written in depth pieces on tin in September 2013 and February 2014. You can see them here.
The belief in TiO2 is really a focus on Argex Titanium ($RGX:CA) (ARGEF) . TiO2 is a challenging market, but RGX has some unique strengths which can allow it to compete in this crowded market with high barriers to entry. RGX is not a mining story – one of the main reasons I like it. I wrote a complete report on the company and the catalysts which can propel it forward in March 2014. You can download a copy here.
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