Don’t Fall For Uranium’s Head-Fake

This story features PALADIN ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: PDN

By Greg Peel

Uranium is a commodity which trades primarily on long term supply contracts. A spot market exists, but mostly to cover temporary utility shortfalls or the like. Iron ore is not dissimilar in its trading nature but in recent years the spot market has taken on a far greater price discovery significance, leading producers to shift from annual to quarterly contract pricing.

The same cannot be said for uranium. However, a departure from the norm occurred in the uranium bubble of 2006 which was driven almost entirely by speculators. The subsequent bust saw speculators either buried or sufficiently chastened, such that very few of their number are still interested in playing. Prices at around US$40/lb aren't nearly as exciting as prices over US$100/lb, just a lot more realistic on a true global demand/supply basis.

The 2006 bubble led to the introduction of a futures contract over spot uranium, even though physical uranium is not traded on any exchange. That contract has not taken off in popularity given it was established after the horse had bolted, which leaves us with two industry consultants who publish an “indicative” physical spot price each week as a market service, via consultation with industry players.

Neither TradeTech nor Ux Consulting tout their published prices as anything more than “indicative”, but lack of any other benchmark has meant a lot of investors have begun to read more into weekly price moves than may be justified. Suddenly investor interest is piqued, given this last week has seen a quite sudden jump in spot price following a couple of years of disappointing false dawns and graft.

TradeTech set its benchmark at US$43.50/lb last week. The rise of US$2 from the week before was the biggest move since October 2009. But TradeTech was quickly trumped by UxC, which lifted its spot indicator all the way to US$46.00/lb. Over the past two years, the spot price has only jumped 10% in a week four times.

Previous jumps have always been about a sudden jump in demand or supply constraint, notes Canada's TD Securities. Given that new reactors require a very large amount of fuel to start up, but not much after that to maintain, such demand blips are understandable. The most recent supply event in October 2009 was a shut-down of Olympic Dam due to a damaged shaft.

The past couple of weeks has seen a coincidence of two such shocks. Chinese buyers have suddenly entered the market (China has the largest reactor building program in the world) at a time when US conversion facility ConverDyn has had to call force majeure on supply contracts due to equipment failures and a labour dispute. It is for this reason uranium stock analysts are warning caution on reading too much into the latest spot price jump.

It does not mean the next uranium bull run is on, they suggest.

A small jump in achieved uranium price translates through to big jumps in the earnings fortunes of pure uranium producers such as Paladin Energy ((PDN)) and Energy Resources of Australia ((ERA)). Investors have thus pushed up their respective share prices lately in the hope of good things to come. But while Ux Consulting also pushed its “term” (longer term contract) uranium price up by US$2 to US$60/lb this week, TradeTech has been publishing the same price for many weeks.

In other words, a big jump in spot does not necessarily mean a big jump in contract prices in the space of a week.

Both BA-Merrill Lynch and Macquarie's Canadian branch issued reports this morning agreeing that this spot price jump is nothing more than a blip, and that share price jumps should be seen as selling opportunities. Both also point to recent production reports from emerging uranium giant Kazakhstan which have exceeded expectations.

Merrills nevertheless has Buy ratings on both Paladin and ERA but only due to improving operating conditions and not due to any great bullish view on the uranium price in the near term. Macquarie's local analysts have a Neutral on ERA. Their Outperform on Paladin is based largely on a positive 12-18 month view on the uranium price, not a weekly view.

The FNArena database shows a Buy/Hold/Sell ratio for Paladin of 3/2/2 and 4/3/2 for ERA.

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