LONDON (ResourceInvestor.com) -- After rocketing from $7/lb in 2001 to a peak of $136/lb in June 2007 the price of uranium has since undergone a significant correction, trading in the $70-95/lb range for the last six months. Shares in uranium companies have generally followed suit with many 50% or more off their peak.
But in the last week the market has exhibited signs of strengthening and analysts from the Royal Bank of Canada Capital Markets have been telling clients that the market could be set for a strong rally.
It seemed a good moment for Resource Investor to revisit the team at New City Investment Management responsible for the Geiger Counter Fund [LSE:GCL] which invests in uranium and nuclear energy markets to hear what they have to say. Here Geiger Counter fund manager John Wong talks about his take on the outlook for uranium.
RESOURCE INVESTOR: What have been the key developments on the supply side in recent months?
JOHN WONG: Supply side shocks are always a key risk in the uranium sector; the rock burst and flooding of Cameco’s [NYSE:CCJ; TSX:CCO] Cigar Lake development in 2006 is a prime example. This delayed the start of production on what will be one of the world’s largest uranium mines from 2008 to 2011 or beyond.
The recent period has been no exception. To date this year, for example, Uranium One [TSX:UUU] has announced a reduction of one and a half million pounds (32%) in its production guidance for 2008 primarily because the forecast for its Dominion mine in South Africa was slashed from 2 million pounds to 590,000 pounds due to power disruptions, equipment breakdowns and a number of other technical factors. This is the second reduction by the company in six months.
Paladin [ASX:PDN; TSX:PDN] has announced that it will be delaying commissioning its Kayelekera Uranium project in Malawi until March 2009 instead of December 2008, while Anglogold Ashanti [NYSE:AU; JSE:ANG] has served notice of a potential force majeure on its South African uranium business; the reason is unstated though probably because of the power crisis in the country.
The net effect is that global supply forecasts for uranium in 2008 have already been substantially revised down; Ux Consulting, for example, has recently reduced its forecast for 2008 from around 129 million pounds to 123 million pounds – and we are still only in the third month of the year. Moreover this trend of producing below target is likely to continue. People underestimate the impact that 30 years of underinvestment has had on the sector. There are simply not enough sufficient trained geologists and mining engineers in uranium to meet demand - it really is tough out there. Indeed I can’t think of a single instance in recent times of an upside surprise, where production has actually exceeded expectations.
There has been little change recently to secondary supply though it may be worth mentioning that it seems ever less likely that the Russians will renew the 1993 HEU (Megatons to Megawatts) agreement when it expires in 2013 (whereby Russia has been selling bomb-grade highly enriched uranium to the U.S. for down-blending for use in nuclear power plants).
RESOURCE INVESTOR: And on the demand side? What have been the key developments recently?
JOHN WONG: There have been no major changes in the level of demand in recent months. The vast majority of uranium is used in nuclear power stations, and demand is currently running at a fairly predictable 185 million pounds per year. It is still of course vastly in excess of primary supply, at 125 million pounds, with the deficit being made up by secondary supply.
Looking ahead forecasts for demand are, if anything, being revised upwards as nuclear reactors are continuing to be approved. A number of governments worldwide are becoming more favourably inclined towards nuclear power in the light of rising fossil fuel prices, increasing geopolitical uncertainty, and increasing concerns about the effect of fossil fuels on climate change.
I feel that this nuclear renaissance is almost irreversible now except in one or two very unlikely circumstances which I shall talk about later. Demand will thus continue on a “slow and steady burn” trajectory while supply will be the main short term driver of the market.
RESOURCE INVESTOR: So what do you see as the outlook for the uranium price in the short and longer term?
JOHN WONG: There are two prices to consider; the spot price, which is currently around $74/lb, and the term price which is around $95/lb.
My guess is that in the very short term – say the next month or two – the spot price will be volatile but that we have probably already hit the bottom. However as the spot market is only thinly traded the price will depend on just who is buying and selling on any given day, and there is still some downside risk in the view of the current turbulence in the financial markets which could potentially cause some distress selling by one or more of the hedge funds.
Meanwhile the market which will determine the term price is also currently thin and much will depend on individual contracts. There is perhaps the potential for it to come down a little but not too much.
Looking further out I am very relaxed about the price and feel that all the indicators have to be pointing upwards. As already discussed it seems highly likely that there will be further disappointments on the supply side. It is not just trained people who are in short supply, there are also shortages of vital consumables such as sulphuric acid (which is the main chemical reagent for in-situ leaching of uranium). There are virtually no specific sulphur mines – most sulphur is produced as a by-product from oil. But the oil producers have little incentive to increase production as it accounts for only a trivial proportion of their revenue. The uncertainty too about Cigar Lake will continue to support prices in the medium term.
RESOURCE INVESTOR: How has the Geiger Counter Fund responded to the recent period of weaker uranium prices?
JOHN WONG: The fund has deployed cash to accumulate assets which we really like. Many uranium stocks are now 50%, or even 70%, off their highs so we have taken the opportunity to add to our positions in these. We also increased our holding of spot uranium recently through our holding in Nufcor Uranium [LSE:NU], effectively buying spot at around $75/lb as we feel that this is close to the floor price.
Our feeling is that in these uncertain times the ideal is to hold assets in companies either in or close to production or they will generate cash and can be self-funding and self-sufficient. They will not have to come back to the market in the short term.
We have also recently extended our holding in Energy Resources of Australia [ASX:ERA] as the company will benefit from the unrolling of a number of contracts which will give it an automatic upgrade in earnings.
RESOURCE INVESTOR: What do you see as the greatest risks in the uranium space right now?
JOHN WONG: There are two risks which are sometimes quoted; the risk of another Chernobyl-type disaster which could dramatically change sentiment, and the risk of disruptive stockpile sales. But I feel that the probability of either of these is very low. The construction and safety associated with nuclear reactors is improving, and although there were quite significant stockpile sales by the U.S. last year these were effectively at the request of the utilities who were very short of uranium.
A third risk to the uranium price could be if the price of fossil fuels were to plummet, perhaps on the back of new discoveries and world peace. Desirable though this scenario may be it also seems very unlikely. Oil, like other commodities, is also becoming increasingly hard to find and extract. It now tends to be found in places which are less hospitable either technically or for reasons of political risk, and there is a shortage of trained people. Although new people are being trained they are having to cope with the double whammy of both lack of experience and more difficult conditions! There are many reasons therefore to believe that oil prices will remain high and that this will help to support the demand for uranium. We are energy bulls at New City Investment Management and have also launched a general energy fund; New City Energy Limited.
RESOURCE INVESTOR: And where are the greatest opportunities?
JOHN WONG: Power is totally fundamental – you only have to look at what has been happening in South Africa to understand how dependent an economy is on power. South Africa must invest, and India, which also suffers frequent brown outs must invest too. Whether or not there is a recession in the U.S. is essentially irrelevant to the prospects for the sector.
I believe that there will be many opportunities in the uranium space. We are still at a very early stage in the bull market. Of course last year was an anomaly when the market overheated and some companies became unrealistically valued – indeed you could almost assume that the price of any company with the word ‘uranium’ in its name doubled or trebled in value!
This year there is likely to be greater realism. Companies without proper resources will get wiped out and there will be consolidation among those with genuine prospects. The supply/demand balance is favourable to companies with long term resources, and many of these may find themselves being acquired by the Cameco’s, ERA’s and Paladin’s of the world who have the ability to raise the necessary funds.
The only reason to be bearish is if you think the whole thrust of the world economy is reversing. Otherwise the uranium market and
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