With Tempered Optimism

This story features ENERGY RESOURCES OF AUSTRALIA LIMITED, and other companies. For more info SHARE ANALYSIS: ERA

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

It had to happen, eventually: the price for spot uranium has stopped falling. Industry consultant TradeTech reports it has lifted its weekly spot price indicator by US$1 to US$58 per pound over the week past. Hereby comes to and end the significant price correction that started in the final week of June 2007 -exactly one year ago- and that took the price of uranium oxide (U3O8), the favoured form of yellow cake, from a bubbly US$138/lb to US$57/lb; a fall of 59%.

Share prices of uranium companies had already appreciated over the past weeks in anticipation that this moment would come, sooner rather than later. Now that the spot price slide has come to a halt, shareholders and investors in companies such as Energy Resources of Australia ((ERA)), Paladin Energy ((PDN)), Bannerman Resources ((BMN)) and A-Cap Resources ((ACB)) no doubt are anxious to find out what comes next? Is the long drawn out misery finally over for the industry? Will we see a swift return to spot prices above US$100/lb, and possibly back to the former peak?

Those experts and commentators who’ve stuck to a rosy view throughout the past twelve months often referred to the views and forecasts of analysts at Deutsche Bank who have kept a firm belief that the price for a pound of yellow cake will soon revert back to US$125, and beyond. Fact of the matter is, however, Deutsche Bank’s views are the most bullish in the market.

Most other experts have gradually lowered their price expectations and some, like Macquarie, now seem convinced that in the absence of any major shift in supply-demand dynamics (caused, for instance, by another major mine shut down) we won’t see the price of uranium returning above US$100/lb anytime soon.

One such example is the team of analysts at JP Morgan who updated its views on uranium only last week. The analysts concluded that overall spot pricing was likely to remain weak throughout the coming third quarter as the Northern Hemisphere summer period historically goes hand in hand with subdued activity levels. JP Morgan does anticipate a stronger overall pricing environment from the final quarter of 2008 onwards, but even then a swift return to US$90 and higher, as suggested by Deutsche Bank, might not necessarily be on the cards. The broker’s new price forecast for calendar 2008 is an average of US$69.60/lb only.

Currently, spot uranium has averaged US$63.20/lb over the past three months. The price at the beginning of the year was around US$90/lb. This would assume that in case of a gradual price recovery from this week onwards the U3O8 spot price could still finish the year above US$90/lb, and remain within the revised price framework penciled in by JP Morgan. However, JP Morgan’s average price forecast of US$75/lb for calendar 2009 implies investors better stick with more moderate price expectations if they want to avoid a repeat of the frustrating experience of the past twelve months.

Such modest expectations would also be in line with TradeTech’s less then euphoric market assessments that accompanied the first upward movement in spot uranium since early December last year: while financial traders and investors have re-entered the spot market, leading to a remarkable uptick in market volumes achieved, the industry consultant also points out demand remains predominantly “discretionary”.

To quote TradeTech directly: “while buying interest is on the rise, the

majority of this demand is highly discretionary in nature. Buyers continue to shop for bargains and, as a result, there remains a gap between willing buyers and willing sellers.”

This is a far cry from the market frenzy between October 2006 and June 2007 that culminated in spot uranium peaking at US$138/lb.

In line with what appears to be the underlying message in TradeTech’s recent market assessments, JP Morgan analysts believe that in the absence of any major production disasters the uranium market should remain well-balanced, possibly even slightly over-supplied, in the near to medium-term future. The broker has currently penciled in an average price forecast of US$75/lb (unchanged from 2009) for 2010 and of US$70/lb for 2011.

This doesn’t necessarily mean that investors should draw from this the conclusion there’s virtually no price upside left for uranium in the years ahead; similar to price forecasts for other commodities, one would assume these forecasts will be subject to multiple revisions in the years ahead. It does indicate, however, that experts such as JP Morgan have by now developed an allergy for blue sky potential when it comes to uranium price forecasts. The broker does consider that firmer demand from countries such as China represents “significant upside risk to demand” over the longer term.

Note that JP Morgan does not only see potential upside risks to its current price forecasts: the broker also considers the possibility the US Department Of Energy (DOE) might “dump” some of its inventory on the market and while doing so it will unexpectedly further depress U3O8 spot pricing.

In May, securities analysts at GSJB Were put forward a more positive scenario, predicting spot uranium prices would start to recover in the second half of this year (they missed that forecast by one week only) to average US$78/lb for the whole year. For 2009 GSJBW anticipates an average spot price of US$93/lb.

If correct, this would still imply that spot uranium, on average, will not be able to return to the price levels of 2007 and 2006 when average prices ran close to US$100/lb for each year, but it would also mean that current prices of sub-US$60/lb should not be seen again in the years ahead.

Well, not before 2010 anyway, because GSJBW analysts anticipate a tighther market than colleagues at JP Morgan and Macquarie, but only for the two years ahead. After that the broker anticipates “fairly steep price decline” as global production is expected to catch up with demand. GSJBW’s longer term price forecasts are for an average of US$85/lb in 2010, US$65/lb in 2011 and US$60/lb in 2012. The broker’s long term price forecast of US$48/lb is significantly lower than JP Morgan’s US$65/lb forecast.

Analysts at Merrill Lynch also reviewed their industry forecasts in early May. Remarkably, many of their assumptions are fairly close to what colleagues at GSJBW put forward with “high confidence”, including the prediction that spot uranium prices should soon climb above US$70/lb and remain above this level until 2010. From that year onwards Merrill Lynch sees a catch up by producers creating surpluses for the global uranium market. This, the broker predicts, will gradually push the price lower to US$65/lb by 2015.

Merrill Lynch’s price forecasts are a combination of a somewhat rosier outlook than JP Morgan and Macquarie, but without any of the blue sky that still characterises projections at Deutsche Bank. Merrill Lynch’s average price forecasts are for US$72.10/lb this year, US$75/lb next year and US$70/lb the following year. While these projections seem to indicate spot uranium is unlikely to revisit the price levels of the past months, they also seem to indicate investors better not hope of prices running past US$100/lb anytime soon either.

Part of Merrill Lynch’s price projections is based upon the fact the broker believes many of the industry’s newer producers require a price of at least US$63/lb for their product to remain profitable. As such a spot price of below US$60/lb would seem unsustainable, even though only an estimated 5% (Merrill Lynch estimate) of global uranium production sells on the spot market. Most long term contract prices are currently being negotiated at prices around US$75/lb.

The broker also believes financial speculators, and financial speculators only, were responsible for the spot price rise past US$100 to $138/lb last year. A view in line with FNArena’s analysis and conclusions as expressed on numerous occasions in the past.

Those investors who have remained loyal to their investments in yellow cake during the price correction over the past year could soon be joined by Deutsche Bank whose investment bankers have been presenting the case for a dedicated uranium investment fund to investors in the US earlier this year. So far any follow-up action has remained absent.

Deutsche Bank is currently forecasting an average U3O8 price forecast of US$89/lb for calendar 2008 (well above any other expert forecast known by FNArena). For 2009 the broker has penciled in an average price of US$108/lb. Even the two following calendar years still carry price forecasts of US$94/lb and US$85/lb respectively.

The main difference between Deutsche Bank and the rest? Deutsche Bank is still prepared to price in some of the blue sky potential that will come from supply interruptions and other unforeseen events. This raises the obvious question: are Deutsche Bank’s current price forecasts above the rest of the market because it has the ambition to launch a dedicated investment fund – or is the latter merely a result of the former?

Macquarie analysts, once upon a time widely quoted for their projection that spot uranium prices might well reach as high as US$200/lb, are currently the most bearish in the market with average price projections of US$65.10/lb and US$60/lb for this year and next. This is compensated by higher price forecasts for the years thereafter: US$80/lb for 2010 and US$90/lb for both 2011 and 2012.

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