The Irony of Markets (Part I)...
Tuesday, October 17, 2006

To many, markets can be puzzling, sometimes leaving its most capable students dumbfounded. This is nowhere more apparent than with the recent problems surfacing in the hedge-fund arena. Billions have been lost covering bets gone wrong, or more precisely markets moving in an inverse direction than was anticipated by the traders. Simply put, they were bad investments. What is more is that these managers allowed their traders to throw more good money at these poor investments.

The uranium market is no exception. Looking at a chart of this commodity one can see it has taken off from its lows in 2000 to new all time highs today. We have two camps forming at these prices as they do in any market and which will push the commodity price in one direction or another. Our first camp consists of 'Uranium Bulls' who believe that the price of uranium will shoot up from today's prices even after this astounding run, and we tend to agree with this camp. The second camp consists of 'Uranium Bears' and believes that the price is over heated at these levels even with the apparent 'tight' market on the supply side. We do not agree with these bears, however their opinion warrants consideration. In life you cannot have the best of both worlds, but within markets sometimes the combination of two very different ideas becomes the prevailing factors.

We view the uranium markets as a complex, non-liquid and inefficient marketplace. Those are harsh words, but the regulations do not allow for the physical commodity to be held by individual investors without paying high fees for storage and trading. Most uranium trading takes place between the producers and consumers. This market lacks middlemen and traders which greatly cuts down on the liquidity of the asset itself. Many have proclaimed that they have never seen a commodity increase this long without a down day, which we must also admit is very impressive. But the reason behind this is because the utilities are not feeling the crunch yet! They are still buying supply from above ground to fuel their reactors and carrying on with their friendly deals with the current producers. Our opinion is that the relationships between buyer and seller have not soured as a result of friendly business over the years, and of course medium ground. Producers are still locked in many older contracts that should begin to expire in 2 years, but are happy to get the money on the table today for new long term contracts. Consumers have to realize, although they state otherwise, that prices are cheap even today after the huge run-up and are content to pay ever higher prices for the cheapest energy producing method on the market.

The first uranium boom was a government subsidized bubble, and by the year 2000 nearly all of those companies had either gone bust or merged with stronger uranium/mining companies. That bust that ended that cycle bottomed in 2000, and many utilities it seems 'rescued' the few remaining uranium miners in their darkest days. Now things are beginning to look up and the tide is turning against the utilities. Although the tide is turning, those uranium miners still have good relationships with the utilities that they did business with in their dark days, thus keeping prices down by not DEMANDING MORE for these OPTIONS. All markets go through these cycles, and the consumers and producers usually take advantage of the other right before the bust.

Our view is a market in harmony right now. Both parties realize that the tide is coming in for the miners and bringing with it many more dollars per pound of their product, however the day will come when the miners begin to demand more money. This is when the bears will be proven wrong, because there are a few ways in which the market can be altered in order to favor the producers. First, holding firm on sell prices and not negotiating down. Second, allow for price increases throughout the contract. The third way would be to do away with the 'option contract format' and create short-term contracts with market contracts. We view this as the most probable evolution of the market as regulations will prohibit many from buying uranium as investors can now buy and hold gold, silver and other precious metals. The current contracts lock in a predetermined amount of material at a set price for an agreed upon time frame. These contracts greatly favor the consumers of this product, and are fairly conservative contracts (we are talking about utilities here). We think that as the market continues its ascending motion that many of these contracts will be 'liberalized' and begin to favor the suppliers for the contracts. This will mean much more favorable terms and conditions as well as higher profits! This will light a fire beneath the market and propel prices higher in a much quicker time-frame.

These past few years have seen overly eager sellers (the producers) due to the high price of uranium with less enthused buyers (the utilities). Price stability has been maintained as a result of uranium miners' need to increase profits after many nimble years in order to develop future projects and the need of their consumers to lockup a supply of fuel for their power stations.

We term the irony of the recent climb in uranium prices as the 'Prevailing Median Price Irony' as both parties are happy with the terms/price (the producers finally coming out of a horrible bust and consumers realizing a coming crunch...thus the prevailing irony) and the lack of middlemen in the equation not forcing prices higher. Our view is that uranium goes to $250 per pound by the year 2015, maybe sooner. That is based on the assumption that contracts become liberalized (in favor of the producers) and the creation of middlemen on a much larger scale in the uranium marketplace. If this perfect storm should happen as described above $250 is more than doable with the current nuclear build out plans.

As outrageous as these claims seem, they are more reasonable than one would think. Why would Iran want a nuclear power plant, or Canada for that matter? After all, both countries have more than sufficient oil and natural gas supplies. The answer is money of course! These oil wealthy nations understand that at current prices for oil it would cost them roughly $2130 to produce the same amount of electricity as only 1 pound of uranium. Well that is a savings of over $2,000! I would be selling my inefficient energy sources at elevated prices and wanting to buy a cheaper more (production and cost) efficient fuel as well. When the Russians pull the last 'Super Power' subsidies out from under the market in 2013, uranium will meet our price target and could very well be on its way to $400 per pound by 2020. There will be more to follow on the uranium markets in Part II, but we feel that this is a sufficient amount of information for this post.

Updates: 

Canalaska sold its 7.5 million pound uranium holding in Ontario.

Pitchstone has bounced off of its recent low and appears to have bottomed at the C$1.10 range. It has run up to about C$1.30 and is looking very good. Look for high volume on a big run-up on no news to sell the stock if no news or industry-wide rallies are taking place as that has been the indicator for the past two sell-offs/run-ups.