It’s starting to look as though the annual “Sell in May and go away” trade is beginning early this year…
All major indexes are down across the board: Apple fell 6% yesterday; commodities including gold, silver, copper, and oil have been especially hard hit.
For the past four years, this spring sell-off has led to the summer doldrums and a fall rally. It won’t be long until the financial press starts talking about deflation, Bernanke, and the advent of QE5 (or is it QE6? I lose count).
It’s times like these when you pull in your bullish horns and look at the macro situation; you raise your cash position and consider what you’d like to buy when the market bottoms.
One sector that has solid fundamentals, growth, and a specific catalyst for share price appreciation… is also the most hated by the markets. I’m talking about nuclear power and its fuel, uranium.
Currently 64 nuclear reactors are under construction during the first half of 2013. Uranium demand is projected to grow by 3% annually through 2022.
Since the mid-1990s, about 18% of the global uranium supply has been provided by former Russian warheads being sold to the United States and converted for civilian use in electric power stations. This supply — which is equal to more than Cameco’s entire production in 2012 — is now shrinking and will come off market by the end of the year.
Furthermore, the delays of new projects due to the Fukushima disaster, which took one-fifth of demand off the market overnight, are ending. New power plants are being built in India, China, Vietnam and Saudi Arabia, the UK, and the United States, among other places.
The price of uranium is at a decade low, at $40 a pound. This unique circumstance sets up a possible supply shock when demand starts to pick up at the margins.
But before we go any further, let me first cover some of the basics of the uranium market…
Uranium the Commodity
Uranium is a metal whose price is determined by its primary use as fuel for nuclear power plants. This price is dictated by long-term private contracts between suppliers and utilities.
Uranium is a commodity and, like all commodities, has a history of volatility.
It moves with supply and demand.
Longer-term uranium prices move with the slow-changing philosophy of green movements.
Spikes and busts are driven by geopolitical black swan events, such as the Cigar Lake mining flood and the Fukushima power plant meltdown in Japan.
Uranium has also has inherent oddities based on the unique nature and use of this material.
Unlike other metals such as copper or tin, uranium is not traded on an organized commodity exchange, such as the London Metal Exchange.
Historically, and in most cases, the uranium price is set through contracts negotiated directly between a buyer and a seller.
As an aside: In 2007, at the height of the uranium bubble, the New York Mercantile Exchange created a futures contract that trades under the symbol UX in U.S. dollars. These contracts were created for producers and consumers to manage risk. The minimum size of one contract is 250 pounds. The spreads are large.
Due to the small number of global producers and buyers of uranium and the heavily-regulated nature of the market, the structure of uranium supply contracts can vary a great deal…
A buyer can lock in a fixed price, or have prices based on the reference points in the process or mining and milling, or add in insurance based on economic corrections.
Remember, a nuclear power plant incurs high up-front costs based on long-term financing coupled with a 30- to 40-year life expectancy. Nuclear power plants cannot be turned off and on, based on the short-term fluctuations of uranium prices.
Contracts traditionally specify a base price, such as the uranium spot price, and rules for escalation. In base-escalated contracts, the buyer and seller agree on a price that increases over the life of the contract on the basis of an agreed-upon formula which may take economic data points, such as GDP or inflation factors, into consideration.
A spot market contract is based on one delivery that is priced at or near the published spot market price at the time of purchase (this type of deal is a rarity). The vast majority, some 85%, of all uranium is sold under long-term, multi-year contracts with deliveries starting one to three years after the contract is signed. The most common term is three to five years, but can go as long as ten or as short as two. The delivery date is usually two years out, and the volume of the delivery can change as prescribed by these contracts.
Obviously, due to the uniqueness of uranium, there are differences between it and other commodities like gold and silver. For one, no one buys uranium Maple Leaf coins.
Companies like the major Canadian miner Cameco track uranium prices based on data put out by independent market consultants Ux Consulting and TradeTech. You can find these prices at www.uxc.com.
Uranium prices reached an all-time low in 2001, costing $7 a pound. This was a low for all fuel. (Oil traded at $12 a barrel). After the dot-com bust, the global economy was reinflated, which produced a slow rise in the price of uranium until a bubble formed around 2005. This was generally called the commodity super cycle, fueled by robust growth in China.
The bubble burst in 2007. The price of uranium peaked at around $137 per pound. This was the highest price in a quarter century. The higher price during the bubble created new mines and new production in old mines.
Then two years ago, Japan’s Fukushima nuclear power plant melted down. This event halted new power pants and restricted financing, which led to the closure of the riskier mines.
The survivors will emerge stronger…
Cameco (NYSE: CCJ)
Cameco is the largest pure play and publicly traded uranium producer. They have the world’s best mine in terms of highest concentration of uranium at the Cigar Lake mine.
Though this mine has had a series of problems due to flooding going back to 2007, it is finally slated to start production this year after many false starts. New demand from emerging markets coupled with the supply reduction as the old Soviet supplies go off market will be replaced by new uranium from Cigar Lake.
Cameco has a $7.25 billion market capitalization and a forward price-to-earnings of 14. Revenue was $2.37 billion in 2012. They pay a 2.10% dividend. Share price was down more than 4% yesterday to $17.50. There’s support on the chart at $16.82 and again just below $13 (2009 low).
Despite the general consensus, the world is not going to end…
Energy demand will continue to grow.
You have to have patience, but if we retest those 2009 lows, Cameco will be a nice buy.
All the best,