Rudi's View | Aug 30 2007
By Rudi Filapek-Vandyck, editor FNArena
“First comes pain, then the gain”. It’s more something you would expect to hear from your personal trainer during weekly workouts at the gym, but the uranium sector has learnt over the past years the saying more often than not applies to the clean fuel industry as well.
Just ask Paladin Resources (PDN) MD John Borshoff. I used to call him on a bi-weekly basis in mid-2001, when Borshoff was working hard to realise his dream, but back then nobody was interested. Uranium was priced below US$10/lb with producers locked into long term contracts that handed all the power to nuclear utilities. To make matters worse, global share markets were plotting through a bear phase and smaller companies, let alone an enthusiastic explorer with no income or short term prospect for income, were not exactly high on the investor attention ladder.
The advent of China as a new economic powerhouse on the global scene, which sparked a Super Cycle for resources in general, and increased attention for global warming, which triggered increased interest for cleaner sources of fuel, dragged uranium out of its doldrums. From early 2004 onwards the spot price of U3O8 (yellow cake or uranium concentrate) began to rise and so did Paladin’s share price.
It turned out the gain that followed was well worth the pain that had preceded, a fact no doubt confirmed by many an athlete as well. The spot price of uranium would surge, with little pauses along the way, for 47 consecutive months taking its price to US$138-136/lb by June this year. Paladin itself had become the quintessential symbol for the re-awakening industry with its share price peaking above $10.00 in April.
Things have gone downhill pretty fast since early July. Paladin shares are now a little above $6. Spot uranium is back at US$95-90/lb. The comparison between the uranium industry and athletes working out in the gym still holds true. In the early nineties a new performance enhancing substance became rapidly very popular among athletes and sports enthusiasts: creatine.
While later medical tests have cast doubts on the precise effects of creatine on endurance performances by athletes, there’s one segment of the sports industry that has never doubted its benefits; weightlifters and body builders. As any of these heavy lifters will tell you, one can stretch a muscle hundreds of times a day, but it can only build up so far. Add creatine to the occasion and your muscle will inflate a significant amount further.
The problem with creatine is, however, that you have to continue using it. Once you stop your muscles will deflate again to the level where they were before.
Recent insights in the uranium industry suggest the sector had its creatine injected in October last year when the world’s largest producer, Canada’s Cameco, announced its flagship Cigar Lake Project was flooded and production would be delayed. Cigar Lake was projected to supply 10-12% of global U3O8 once it had reached full production.
For the uranium industry creatine came in the form of hedge funds and other speculative investors who jumped on what seemed like an obvious opportunity in a seemingly tight market with a chronic supply problem. The affect on the well trained uranium muscle proved to be significant. After rising to US$50/lb by the third quarter of last year, spot uranium would quickly inflate to US$72 by year end. Six months later it was priced at US$138-136/lb.
We all thought it was the effect of panicking US utilities trying to secure what was lost due to the Cigar Lake delay, just like we thought back in 1992 that the 100m sprint gold medal winner at the Olympics of Barcelona, Linford Christie, was simply a well trained, highly talented super-athlete.
New insights have taught us a different reality.
The market for uranium is nothing like those for copper, oil, soy beans or wheat where sellers can offer their inventory and likely receive bids at or close to the spot price. The spot market for uranium is very much a marginal corner as most buyers across the globe try to secure long standing relationships with producers such as Cameco, Areva, Rio Tinto (RIO) and BHP Billiton (BHP).
As a result, those speculators who turned into forced sellers when global liquidity dried up in July-August have found the going rather tough. US utilities were already of the view that uranium spot prices had inflated beyond market fundamentals when the spot price crossed US$50/lb in 2006. If sellers are forced to dispose of their assets, and there are no aggressive buyers around, there is only one way to go for the price of the product. So far U3O8 has gone from US$138-136/lb to US$95-90/lb in a handful of weeks only. Close followers of the market believe we may not have found the bottom yet.
Some experts, like industry consultant UxC, believe the spot price may sink to US$70, or approximately the level of spot U3O8 after Cameco announced its disaster at Cigar Lake last year. That would make the comparison with creatine almost too accurate.
Spot uranium may be intrinsically different from the copper spot market, but dynamics in the iron ore industry are in many ways similar (there are key differences too). The iron ore spot market only represents a fraction of the total market and long term supply contracts are the rule. Even a major producer such as OneSteel (OST) in Australia, for which the excess annual production of iron ore is nothing but a bonus, prefers to establish longer term relationships with customers rather than to gamble on the spot market.
It just so happens spot iron ore prices recently reached US$100 per tonne for the first time ever. Can they reach as high as US$138? They might, but it will take years, not six months if they ever do.
There are no speculative funds in the market buying up iron ore in order to sell it at a profit later.
It would seem the saying “first comes pain, then the gain” applies once more to the uranium market as strong fundamentals and ongoing tight supply forecasts, at least for the medium term, should allow for a price recovery once the current price correction has run its course.
However, whether spot uranium will ever reach its former price peak again, and the speed at which this might be achieved, lies now in the hands of the speculators.
What would the U3O8 spot price have been without these professional speculators over the past ten months? Unfortunately we will never know the answer, just like we will never know how fast Linford Christie would have run without the usage of creatine.
But there is a chance we might experience how high spot uranium can climb without its own creatine as some utilities, no doubt, are now hoping most speculators will have learnt their lesson and turn their focus elsewhere from now on.