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Copper & Uranium

Today's Maven Monday comprises two short articles clipped from last week's Maven Letter. The rest of the letter focused on identifying stocks offering the best leverage should the metals markets do what they usually do and go on a run to start the New Year.

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From The Maven Letter: December 6, 2017

The Copper Argument

BHP Billiton released a nice article last week summarizing its bullish view on copper. Describing the red metal as “an extremely attractive commodity,” the company gave ten reasons – five related to supply, five related to demand – supporting its pro-copper stance.

I thought it a nice, clear argument that captures all the pertinent points. To me, copper is the obvious bet in the electrification gamble. Lithium, cobalt, graphite – these commodities certainly offer opportunity, but between opaque markets, difficult metallurgy, oligarchic control, and the potential for demand to shift away these commodities carry a lot of risk for investors.

Copper, by contrast, is essential no matter how batteries or power generation evolve. It’s a huge, open market. The metallurgy is well understood and no one controls the commodity. Electrification is an incredibly important movement in the world and offers immense investment opportunity, but to me copper is the obvious way to play.

And copper is moving into a structural deficit situation. The market is increasingly aware; I have watched investment interest in copper companies grow in recent months. But most of the upside is yet to come.

According to BHP’s nice summary, here’s why.

The Supply Side

  1. Copper production from currently operating mines will decline over the coming decade because grades at the large porphyry mines that dominate global supply are falling. The best parts of these massive deposits have already been mined. New mines will have to be developed to offset this decline.
  2. Lack of big exploration successes. The world currently relies on giant porphyry deposits that were discovered and developed decades ago for much of its copper needs. Similar deposits are NOT being discovered today. “Analysis shows that Tier I discoveries across the minerals sphere have become scarce in the new millennium, with an additional slowdown post Great Financial Crisis… Our view is that it is extremely likely that the copper cost curve will steepen in the 2020s as the absence of a significant new generation of Tier I assets will leave lower quality and/or higher cost deposits to fill the looming gap.”
  3. Rising jurisdictional risk threatens new supply. The only region in the world where discoveries increased in the 2000s versus the 1990s was in Sub-Saharan Africa, where jurisdictional risk is relatively high. “All other things being equal, the higher the level of above ground risk, the lower the probability of a discovery proceeding to development and, ultimately, contributing to global production.”
  4. Water. Estimates suggest it takes 1,600 litres of water to produce the copper needed to build one conventional internal combustion engine vehicle. Electric vehicles need four times that much copper. Several of the world’s most important copper regions are arid, which means access to and permission to use water is increasingly important and challenging for copper production.
  5. Rational market. BHP points out that the copper market has shown itself to be reliably rational, with the 90th percentile on the cost curve serving as a reliable floor for copper prices during cyclical downturns. A rational market means fundamental arguments – supply and demand – should rule the day.

The Demand Side

  1. China. Household copper demand is rising in China as residents of all but the most developed cities still lag the developed world in terms of urban consumerism.
  2. India. India’s urban consumers are decades behind their Chinese counterparts in terms of all key end-use sectors important to copper. And the urban population share itself is still low.
  3. Rising energy demand. Demand for electricity is rising inexorably and copper is the conduit.
  4. Electrification of transport. As noted, battery-powered electric vehicles require four times as much copper as a conventional car. And mid-range estimates suggest the world will have some 230 million electric vehicles by 2030. The demand is immense.
  5. Wind and solar. “Attractive long run economics, plus the important role that renewables will need to play in the decarbonisation of the world economy, promise a sustained high growth path for wind and solar… Fast growing and copper hungry - that makes the wind and solar revolution a worthy conclusion to our catalogue of reasons to like copper.

You could argue that BHP is biased to like copper…but you can equally argue that major miners have to look way ahead if they want the decisions they make today to benefit the company tomorrow. Mining is a long-play game and BHP is confident that copper is a key commodity for its success over the coming decades.

I happen to agree!

Uranium’s Big Players Are Shaping The Game

Rather than sit around and complain about low uranium prices, the world’s uranium producers are doing something about it.

On Monday Kazatomprom announced that it will reduce uranium production by 20% over the next three years. The Kazakhstan national uranium company is the largest uranium producer in the world; a 20% cut would erase 11,000 tonnes of annual uranium output.

The immediate impact: in 2018 Kazatomprom will produce 10.4 million lbs. less uranium than previously planned, which represents a 7.5% cut to global output. A year ago Kazatomprom made its first production cut, reducing output by 10%, but that only erased 5 million lbs. of U3O8. The 2018 cut is twice as large.

And it comes just weeks after Cameco suspended operations at McArthur River for 10 months, which removes another 12 to 15 million lbs. of output.

Do the two moves fix the market? No, but they really help. With Japan still running only a handful of reactors the nuclear fuel market is still well supplied for the next few years. Stockpiles are large and there is lots of excess sloshing around in the spot market.

However, nuclear utilities need to lock up uranium supplies years in advance, because it takes almost a year to turn yellowcake into nuclear fuel rods and because running out of nuclear fuel is not an option (reactors melt down without enough fuel).

After taking Kazatomprom’s cuts into account, uranium supply and demand look pretty balanced in 2019 and 2020…but the market moves into deficit after that, as nuclear reactor builds across the world complete. Nuclear utilities are going to lock in new long-term contracts well before that deficit arrives, to secure their uranium needs.

“2019 and 2020 may have moderate surpluses after taking into account the Kazatomprom cuts; we believe fuel buyers will become increasingly nervous on security of supply beyond 2020 and be willing to have more serious discussions on higher prices for term contracts. Overall, this is in line with our view that the uranium market has long-term price upside as the current spot price is uneconomic.” --- RBC Capital Markets

Kazatomprom’s move inarguably brought the uranium bull market forward. The only question is: how much? Is now the time to buy?

Uranium stocks like to go on a run right alongside gold stocks at the start of the year. The questions to ask are:

  • Have uranium equities already made their seasonal gains? Most uranium stocks with advanced assets are up some 35% on the double whammy of the Cameco-Kazatomprom news.
  • Further gains will require the uranium price to lift significantly from here, and now. Is that about to happen?

As much as I want to believe that uranium is poised to start a serious run, I need to see clear evidence of a run – rather than just a reaction to news – before I will believe it.

A real uranium bull market will start when news breaks that nuclear utilities are signing new long-term supply contracts. We haven’t heard that yet and I will wait until I hear of precisely that before declaring a new uranium bull market.

Last year the uranium price and uranium stocks gained a bunch in January and February, following news of the first Kazatomprom cut. This year, my guess is that most of those gains have likely already happened.

Last year those gains fell off again; this year they may sustain better, given that the sector’s fundamentals are now much stronger, but as I said I won’t believe that we are in a uranium bull market until I hear of nuclear utilities signing new long-term contracts at strong prices.

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