Is There A Lesson For Oil In Uranium?

This story features PALADIN ENERGY LIMITED. For more info SHARE ANALYSIS: PDN

This story was first published two days ago in the form of an email sent to registered FNArena readers.

By Rudi Filapek-Vandyck, editor FNArena

The similarities between crude oil in 2008 and uranium in 2007 are so striking that I am genuinely surprised nobody else has picked up on this thus far. Thinking about it, it’s probably because uranium has all but dropped off most market watchers’ radar since the Big Price Correction kicked in for the once superhot commodity.

All markets are different, and this is especially the case when comparing oil with uranium, but it seems to me that investors can find a lot of today’s sought after answers about the drivers and the outlook for oil prices by looking at yesteryear’s market experience with uranium.

Let’s start with what I would like to think are some very striking similarities. Last calendar year, spot uranium entered the first weeks of January at a price of US$72/lb.

Bullish market analysts had predicted the price could well reach US$75/lb in the medium term, but to everybody’s surprise spot uranium oxide, or U3O8, just kept on rising. Towards the end of June it reached a peak at US$136/138 (depending on which weekly spot price indicator one refers to).

By then everybody was convinced spot uranium would at least double by December from the US$72/lb at the beginning of the year. Uranium had already doubled in price throughout the two previous calendar years, so 2007 would simply see a continuation of the trend. Instead, spot U3O8 went the other way. It ended at US$60/lb three weeks ago and has remained at that price level since.

Before we continue with uranium, let’s pause for a quick update on oil: West Texan Intermediate (WTI), widely regarded as the benchmark amidst various blends of and products derived from petroleum, averaged about US$72 per barrel in 2007. Most market expectations at the end of last year were centred around an anticipated price average of circa US$80 per barrel for this year.

Instead the price of oil has continued rising, surprising even the most bullish forecasters, and now that we’re in the last week of May, WTI futures recently peaked a little above US$135 per barrel.

The general expectation in the market is that oil is likely to rise further, and expectations are being lifted accordingly. This is in contrast with most experts’ views earlier in the year when the general credo was “surely it’ll come down soon”.

Here’s one difference between oil now and uranium then: fiery debates are taking place between market experts with many years of inside oil market experience whether oil at US$135 per barrel is the result of: a) shifting market fundamentals, b) a weaker US dollar, c) a combination of both; or d) none of the factors mentioned; this is just another investment bubble inflating.

Back in 2007, when uranium continued its climb, only a few industry veterans working for nuclear utilities (those who had to buy in the product) questioned what was happening in the market. The rest of us simply thought this is the result of changing market dynamics (of course those utilities would complain, wouldn’t you?).

We found plenty of reasons why uranium should be dubbed “the new gold”; as an alternative to expensive oil, as an alternative to fossil fuels (amidst an increasing climate change awareness), as a means of diversification for countries dependent on only one or two sources for their power grid.

It all seemed to fit perfectly, until we found out that uranium should have never been priced above US$100/lb – the fact that it did was simply the result of overenthusiastic financial investors and speculators (a view shared by many more market watchers and specialists by now).

Here is where the uranium experience teaches us a very important lesson: as prices continued to rise, overall perceptions and views in the market changed as well. Not only was there the magic of ever climbing prices (nothing, and I repeat nothing is as attractive to investors as continuously rising prices), which obviously led to more and more investors buying into the sector, but gradually securities analysts and sector specialists started to lift their expectations as well.

As such the market created its own framework around what in essence becomes a self-fulfilling prophecy: as prices continue to rise more investors jump on board, securing prices continue to rise. Securities analysts find themselves hopelessly behind the curve and decide to make a step forward with bolder price projections which in return further push up market expectations, this leads to increased confidence and thus more buying by investors. Next thing you know it, securities analysts are behind the curve again and expectations are being lifted further.

The funny thing is that when one looks back in hindsight, it all looks so simple and so easy decipherable, that it is almost unbelievable that this is actually how it all happened.

The sad thing is that all of this is only easy when one has the luxury of looking back in hindsight. Back then even experienced people working in the industry truly believed it was all real, logical and perfectly justifiable.

Paladin ((PDN)) bought uranium on the spot market to compensate for its early production shortfall at prices close to what later proved to be the peak in the investor mania cycle. However, the ultimate pivotal event during last year’s experience was the change in attitude by Citi resources specialist Alan Heap.

Throughout the strong run up in prices in 2006 and the first months of 2007, Heap had stoically left his price projections at levels far below actual market developments. As colleagues and other experts succumbed to what they believed was the new reality, Heap’s forecasts looked more and more out of touch (and that’s a nice way of saying it). Eventually, he too decided to revise his forecasts, to prices near the spot uranium price at that time.

Ironically, Heap’s revised forecasts were published less than a week before the U3O8 spot price started to decline. This not only shows the truth behind the saying that when the last bear in the market changes his view, time has come to exit the market, but also that ultimately everybody gets sucked in by principle of the train has left the station, wouldn’t YOU want to be on board? (The longer it continues, the harder it is to resist).

The media plays an important role in this proces as well. Guess what was widely reported as being the next price target for spot uranium somewhere in the second quarter of 2007?

US$200/lb. Exactly, the same price as is now the case for crude oil. Macquarie’s widely reported US$200/lb price mark for uranium shares one key element with Goldman Sachs’s even wider reported US$200 per barrel target for crude oil: in both cases we have been subjected to some very selective reporting by the media.

Neither Macquarie or Goldman Sachs actually made that prediction. In both cases, the analysts in question considered a very bullish scenario (when everything falls into place that can possibly fall into place) under which it could well be possible that spot uranium/crude oil could reach as high as US$200.

Of course, amidst an overall environment of magically ever rising prices and experts lifting their forecasts, one after the other, such finer detail is literally swept under the carpet. So US$200 it is (because it fits in with the overall framework the market has created for itself) – and the number is copied and duplicated and repeated,…, until we all believe that US$200 is actually the logical next target.

It’s called Bull Market behaviour. This is how self-fulfilling mania is created. It is a process that is very difficult to predict, but when it gets into full action it takes on a life of its own. Everything becomes a reason to buy, and there are plenty of justifications around. Any doubt, or questions, are simply cast aside. Prices are rising, what more does one need to know?

Everything I just recalled from last year’s uranium bubble has occurred in the oil market this year.

I think this pretty much answers the question whether at US$135 per barrel (compared with circa US$60 a year ago) market fundamentals or investors are at work. However, and this is the catch in this story, I also believe that those experts who put the blame solely in the hands of investors and speculators are equally missing a key point.

What the experience with uranium shows is that in the beginning there has to be a favourable shift in market fundamentals, or at least in the perception of these fundamentals.

In uranium’s case it was the sudden prospect of a supply shortage caused by a delay in one of the largest new mining projects in the sector. Mind you: there actually was no physical shortage, it was the mere general perception there would be one.

Despite the fact that Cameco’s Cigar Lake project has been further delayed since, market experts are still unsure whether the uranium market, in its totality, will actually record a deficit in the years ahead. Even the most bullish of the market experts, Deutsche Bank, recently conceded on its current forecasts the market should have a marginal supply surplus this year and possibly next year too.

That doesn’t take away the fact that most market experts and securities analysts would argue that uranium should be trading in the vicinity of US$90/lb instead of the US$60 it is trading at right now.

Coincidentally, that is an oft mentioned price level for crude oil as well. As such, and oil being oil, it’s probably a fair assumption that the world will have to get used to oil priced above the US$100 per barrel price mark. As such, the oil market, and the world as we knew it yesterday, has fundamentally changed over the past few months.

Maybe that’s the key conclusion we should all draw from this year’s events so far.

Investors better be careful: the experience with uranium also shows that while prices can easily overshoot to the upside, they can do likewise to the downside. I am by no means suggesting we will see crude oil priced at US$60 per barrel by mid-2009, but I wouldn’t be surprised if we would see some serious corrections kick in. But when? And what will be the trigger?

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