Scott Wright August 3, 2007 3391 Words
With a commodities bull market in full swing, commodities-stock investors have enjoyed incredible results leveraging their favorite commodities. And commodities-stocks’ performances have vastly exceeded the impressive double of the major market indices over the last four years.
As one of the few stock investors to have traded this commodities bull since the beginning, I have observed different commodities begin their bulls at different times with most developing different trading patterns. All commodities are not created equal, yet many of these trading patterns are indeed predictable to some extent.
Most commodities stocks flow and ebb in harmony with the market action of their underlying commodities. And within the greater uptrend of a commodity, technical trading patterns typically emerge that corral the ever-important sentiment swings and keep a respective commodity’s bull orderly.
The precious-metals stocks feed off long-term bullish fundamentals in which very tradable technical patterns have emerged allowing speculators to successfully trade the extremes within their strategic uptrends. Energy and base metals stocks also feed off long-term bullish fundamentals, but have more measurable tactical tools that traders can use such as real-time global stockpile fluctuations.
The individual PM, energy and base metals commodities and their stocks have all had quite a run thus far, and with their enduring bullish fundamentals should have a ways to go before they lose their luster. But as an investor who continually strives to understand commodities and monitor their trends in order to effectively trade their stocks, one commodity in particular has vexed me and so far eluded standard trading techniques.
This commodity is a hybrid of sorts and joined the bull run a little bit later than the rest. It is extracted from the earth via the same mining methods as many of the metals, yet its end product is energy in the form of electricity. Uranium is what I am referring to. And because it embodies the characteristics of both metals and energy, it is garnering attention on multiple fronts.
Uranium and uranium stocks have been best of breed among the commodities and commodities stocks of late. And the contrarian crowd that got an early jump on the stocks of the companies that are exploring for, developing and producing this mineral have enjoyed incredible gains. In the last couple years any stock that has anything to do with uranium has just soared. With the commodity and the stocks continually rising, those traders that waited for a pullback so they could layer in positions were endlessly frustrated, feeling like they were chasing a train they just couldn’t catch.
But this mad rush toward uranium stocks has been warranted due to the smashingly-bullish fundamentals of their underlying mineral. Uranium, also known as yellowcake post-processing, is converted into nuclear fuel. And nuclear fuel is a very powerful energy source that is finally starting to be recognized as clean, scalable and economical and will play a vital role in fulfilling the world’s energy needs of the future.
Few people realize that even today about 16% of the world’s electricity comes from nuclear power. And because other sources of electricity are falling out of environmental favor and are running into supply and economic problems of their own, nuclear power is expected to command a much greater market share of the world’s future electricity needs.
In previous commentaries I’ve written on this exciting uranium bull, I dove in depth into the strategic fundamentals of this market. I encourage you to explore the world of uranium and nuclear power in either of my last two essays. But today, with uranium’s initial drive stabilizing and there now being a greater market understanding of the importance and utility of nuclear power, I’d like to take a closer look at how investors can capitalize on this bullish secular trend.
Now the newest way to play the uranium game is via the futures markets. Earlier this year uranium futures contracts were introduced for the first time ever on the NYMEX. Adrenaline-junkie speculators had been salivating over the opportunities that can arise from this. But like most newly-introduced futures contracts, extremely low volume has led to a lack of liquidity and a slow ramp-up period for these uranium futures.
But even when uranium futures establish more of a fluid market, I believe stocks will continue to be the best way to capture the essence of this uranium bull. In the last couple years literally hundreds of uranium stocks have hit the markets and are chasing the massive flood of investor capital entering this sector. Unfortunately many of these companies are simply trend-chasers and will eventually fail. But in this recent run-up, nearly all uranium stocks skyrocketed with traders exhibiting an anything-uranium-to-the-moon mentality.
This mentality spawned from the fact that uranium had been host to only one upleg, albeit an extraordinary one. From its low of $7 per pound in 2000, uranium’s parabolic rise took it 1,800% higher to its recent all-time high of $136! With a breathtaking rise like this, it is no wonder the stocks followed suit. Now after an incredible four year run of consecutive month-over-month rising prices, uranium has finally decided to take a breather.
With uranium-stock investors not accustomed to price declines of any magnitude, July uranium’s shedding of $16, or 12%, has them selling like mad. So with sentiment finally swinging towards a balance in order to cool off the strong euphoria surrounding uranium stocks today, I believe the next rush into uranium stocks will naturally be a little more calculated with a little more due diligence required from investors.
Blind faith worked for any uranium stock up until now, but if a uranium-stock consolidation is upon us, then investors are going to need to be a little more prudent in their stock picking. With this in mind I decided to embark on a uranium-stock expedition in order to sift through the countless uranium stocks out there to find a handful that have their acts together and are positioning themselves to outperform the herd.
Now though uranium stocks have exhibited incredible gains over this upleg, the overall market for uranium stocks is still tiny compared to the stock capitalization of other commodities-stock sectors. For a commodity that at today’s prices has annual demand equivalent to about $21b, the capital markets for those explorers and producers that are tasked to supply the yellowcake is miniscule. There is a lot of room to run yet for uranium stocks.
And the reason there is so much upside potential for uranium stocks, even at today’s prices, is because there is a massive imbalance in the uranium trade where mined supply comes 70m lbs short of annual demand. And with the stockpiles that have been filling this gap quickly dwindling, this uranium shortfall must be picked up by the miners. This will not be an easy task as global electricity demand is expected to double over the next 25 years.
Now as far as resources are concerned, there is certainly no shortage of uranium housed within the earth. But when the ravenous uranium bear that spanned the last 20 years of the 20th century virtually eliminated the entire uranium mining industry, there was little left to build on to secure the uranium needs of the future.
In the late 1980s and 1990s very little capital was spent exploring for uranium and developing the already-identified deposits. And most of the largest uranium explorers and producers that were active back then either do not exist today or long ago spun off or shut down their uranium operations. This has led to very few companies remaining today that are equipped to lead this resurging uranium market.
So with uranium prices now triple the previous nominal all-time highs of the mid-1970s, mining companies now have an incentive to find it, mine it and sell it. With this there are countless mineral explorers shifting their focus to uranium and recruiting uranium-mining veterans that have the knowledge and expertise to perform successful uranium exploration.
Many of these elite geologists and mining engineers that have past experience in the uranium business are indeed mature in their years, but are starting to come out of the woodwork as the lucrative compensation packages dangled in front of them are impossible to resist. And not only are these veteran experts now a hot commodity in this uranium market, but so is the exploration data from past drilling and metallurgical analysis.
From the 1960s through the early 1990s, billions of dollars was spent by some of the major energy companies of the time exploring for and developing uranium deposits. Major North American companies such as Exxon, Conoco, Phillips, Westinghouse, Kerr McGee, Energy Fuels, United Nuclear, Union Carbide and many others compiled literally warehouses full of data on their uranium finds.
Some of these finds had partial or full development on what might have been economical deposits, but most only went as far as initial drilling and perhaps pre-feasibility studies. The fact is the uranium bear caused these companies to drop all of their uranium projects, write them off as losses, and seal their warehouses of data so they could only collect dust.
Of all the global uranium exploration in the last 50 years, much of it occurred in the United States. With Cold War uranium stockpiling as well as its growing consumption of nuclear-generated electricity, many of the major energy companies looked to uranium as a strategic commodity for their businesses. Even today the US requires about 45m lbs of uranium annually to feed its 104 reactors that supply around 20% of the country’s electricity.
But with historically-low uranium prices pushing these major companies out of the business, the US uranium market essentially dried up. Interestingly only about 4m lbs of uranium were produced within the US borders last year, leaving a whopping 90% of its demand coming from stockpiles and imports.
Because of this many of the new juniors that have hit the market in recent years have chosen the anemic US uranium industry to stake their claims. The US is uranium abundant with its in-ground resources and has a rich history of uranium production, so for these juniors their task at hand is to revive this once-prosperous uranium market.
The other major reason prospective uranium miners have chosen to flock to the US is because of the historical exploration and development that I mentioned above. When uranium deposits have already been discovered, explored and in some cases mined, this greatly reduces the barriers to entry in this very capital-intensive business.
This historical data acts as treasure maps for today’s uranium companies. The most difficult step in bringing any mineral to market is finding it, so if these companies already have the map, and in many cases a picture of the depth and breadth of a deposit, this greatly reduces the massive capital expenditures that would go into finding and defining a deposit.
These up-and-coming uranium companies have been able to purchase this historical exploration data for pennies on the dollar compared to the replacement costs of replicating the exploration all over again on their own. When historical data on exploration projects is available in which tens or hundreds of millions of dollars were spent in addition to the huge intangible time costs, these juniors gain a ready-made foundation from which to pick up where their fallen comrades left off.
So as the US plays host to a flurry of activity to bring back to life its once-dominant uranium market, a similar trend is emerging in other parts of the world as well. As you can imagine the Russians also spent quite a bit of time and money exploring for uranium throughout Asia from the 1960s through the 1990s. Many juniors are finding excellent historical data and development on uranium deposits that were past-explored and even mined by the Russians.
In addition to the uranium explorers targeting historical resources, there are those that comprise what I call the land-play group. These companies, typically junior level, are flocking to proven uranium districts with the hopes of capturing a piece of the pie. Again, finding a mineral is always the most difficult step in bringing it to market, and these juniors are betting their farms on land positions that hopefully have a higher-probability-for-success chance of yielding uranium.
These hopes are based on simple geologic principles. If strong mineralization is found in one place, probabilities favor similar mineralization within the same basin/belt/trend. Knowing this, a company will stake mineral claims on land adjacent to a location that may host a strong exploration project with defined resources or an actual producing mine.
But this class of uranium company is a little more risky from an investment perspective. Whereas most of the companies that plan to expand and develop historical uranium resources usually know what to do with them, this is not always the case for the land players. For many land players their only shot at ever unearthing a pound of uranium is through a fortuitous claim that gets them acquired by a senior company. Many are trend chasers simply trying to suck in capital from this mad rush in uranium stocks.
Out of the pack of trend chasers though are an elite few that expertly stake claims and are led by technically savvy management teams that have a knack for discovery. These companies are active and aggressive in their exploration programs and are able to consistently produce bullish information flow to the markets that strengthen their portfolios. But you need to wade through the muddle in order to uncover the companies capable of this.
Overall in my research on the individual company level, a number of macro trends were revealed that bolster the case for a uranium bull of the secular sort. Most eye-opening was the fact that of the hundreds of new companies joining the uranium game, very few are in position to bring a fresh supply of uranium to market in the near term.
Several things contribute to this alarming trend, and most apparent is the simple nature of mining. It is a fact that it takes significant time and capital to discover, develop, permit and commission a uranium mine. For some of the larger deposits it can take up to a decade and hundreds of millions of dollars to complete this process. Interestingly, the world’s largest and richest uranium mine located in Canada’s prolific Athabasca basin took 12 years to get from initial discovery to commercial production.
Even the already-discovered deposits that may have been past-producing or have extensive historical data have significant obstacles to overcome before they can advance. Since most of the world’s mined uranium production and future resource base resides within First World countries, there are First World governing agencies that strictly regulate the ins and outs of potential uranium mining operations. This leads to the enduring quests to obtain permits.
The permitting process is extensive, expensive and very time-consuming. And due to the nature of uranium, more specifically the nuclear fuel end product of this mineral, environmental and legal challenges are constantly presenting themselves to the uranium miners. This is why high uranium prices are necessary, so the uranium miners have incentive to overcome the hassles, which equate to dollars, that go into the operation of a uranium mine.
And if a uranium miner is lucky enough to overcome the initial hurdles of procuring permits, lining up funding, and has a positive decision on a mining plan, it must then concern itself with processing. Now there is a growing number of mines that have the geologic makeup to extract and process their uranium via solution mining methods, most commonly In Situ Recovery (ISR), that don’t have to worry as much about this. This is because ISR processing facilities are typically on site and cheaper to construct than conventional mills.
But most uranium ore is still extracted via the conventional dig/haul/crush mining methods. And there is a major structural problem today as the mills that process this ore are rare commodities in themselves. When the uranium mining business went belly up in the 1990s, so did the mills. And today there is a major shortage of mills to process not only the uranium of the future, but today’s uranium.
There are only four mills operating in all of North America today. Therefore near-term uranium producers are clamoring to find somewhere to send their ore. In many cases they will be forced to construct their own mills if they ever want their uranium to hit the markets. So this processing conundrum is adding another capital-intensive and time-consuming step for many of the emerging uranium producers to overcome.
In order to remedy this, there is a big industry push to bring to life mills and other processing facilities that reside farther down the uranium life cycle. Some companies are attempting to resurrect past-producing mills through refurbishment efforts, which is the cheaper route, and some are finding it necessary to construct brand new mills either by themselves or with a consortium of regional peers.
The major challenges surrounding mills are they are very expensive to construct and permitting is equally difficult, if not more difficult, than obtaining mining permits. Uranium ore tailings disposal is of particular environmental interest to not only the regulators but the local population of wherever the mill may reside. Therefore the design, operation, maintenance and upkeep of uranium mills are highly scrutinized.
On top of all these pre-production challenges, uranium miners must overcome the general market perception of uranium mining. Many historical uranium districts have flat-out banned future uranium mining due to either past issues or preconceived negative notions.
So as you can see, the process of building a uranium mining operation is quite intensive and these miners are finding a hostile world resisting their efforts. I did not realize the intricacies of this business until researching which companies to invest in. Only then can you truly understand the strategic issues that the uranium mining industry is faced with.
After all this research it is not surprising that there are actually very few companies in good position to capitalize on this uranium bull. So as uranium and uranium stocks find a balance as the not-so-tight-anymore spot market leads to a correction to bleed off the greed built up in the last couple years, stock picking will be ever-more important.
The future of uranium stock investing and speculating will likely command more precision than ever. With the initial run-up of uranium stocks out of the way, those investors willing to risk their hard-earned capital on future uplegs should smartly choose where to entrust it.
At Zeal we are beginning to layer into uranium stock positions in anticipation of the next upleg. We are closely watching the uranium spot market and uranium’s correlation to the energy markets to assist with the timing of our trades. There may indeed be more room to run in uranium’s downside, but in order to catch the bottom it is important to start layering in now.
To feed the trades we recommend in our newsletters, we are using the invaluable fundamental research that comprises our most recent Zeal Favorite Stocks Research Report. In our freshly released report we detail in-depth fundamental analysis on our 20 favorite uranium stocks.
The stocks profiled in this report range from high-probability-for-success junior explorers, to near-term producers, to elite miners. If you would like to receive uranium-stock picks along with other commodities-stocks picks embedded in cutting-edge commodities market analysis, please subscribe to our monthly or weekly newsletters. And if you would like to have the entire uranium stock report at your fingertips, you may purchase it today.
The bottom line is the hottest commodity in the markets today is uranium. The success of this mineral has called for new and old mining companies alike to flock to this market in order to find and profit on yellowcake. Any uranium stock has had the Midas touch and has simply shot to the moon.
But with uranium finally taking a breather and putting the brakes on one of the longest and strongest uplegs of any commodity, investors need to step back and evaluate their favorite uranium stocks. It will be more important now than ever to perform prudent stock picking for the next uranium upleg. Even after this necessary correction runs its course, there should still be a lot more room to run in this uranium bull.
Scott Wright August 3, 2007 Subscribe at www.zealllc.com/subscribe.htm