Forgotten Risks to the Market
Friday, July 13, 2007
The market seems to have treated us quite well over the
past week, with investors rushing back into uranium stocks due to geopolitical
risks in Africa becoming front page news as well as more bad news regarding
Cameco's Cigar Lake. Other good news for metals/mining stocks was the Rio
Tinto/Alcan deal, which was at a 38% premium to Alcoa's all stock deal. It now
seems apparent that miners are more than willing to shell out their cash to buy
assets, which to us indicates a very strong commodities market for years to
come.
The Chinese seem to have put an emphasis on investing in
African resources over the years, our first memory of this was their investment
in Sudanese oil years back, but now they are focusing on African uranium. They
recently had a senior mining executive kidnapped, and even shut operations down
until the problem could be resolved. Today, the executive has been returned,
most likely for a ransom, and it is now business as usual. This is a fairly
common practice in Africa, but one which could become quite annoying as well as
much more dangerous in the years to come. Hopefully with these countries getting
a second chance with their resource wealth with the current booming commodities
market, they will invest their money into helping enhance the quality of life of
the citizens rather than seeing how much money they can swindle into their own
personal slush funds. Maybe we will see the mining companies do this to an
extent, much as the oil companies have done in areas around the world with
similar problems. Investors became complacent about the risks associated with
African uranium, but had a rude awakening with this news. African uranium should
be discounted as problems such as these can arise at any moment, just think
about every time Shell has to shut operations in Nigeria due to rebels
interfering with operations. One bright spot for now is Namibia, which we have
pointed out numerous times for its uranium wealth and geopolitical stability.
Currently the country does not have the same problems as the rest of Africa and
is possibly even a better place for business than South Africa (due to SA's
rules requiring minority ownership in projects, which is usually just given to
an empowerment group).
Cigar Lake is a situation which could get much worse before
it gets any better. In fact, one would have to assume this is the case right
now, which is why we are not adding to our very small position in the company.
We keep that position as a hedge to the general uranium industry as well as to
keep some exposure to the market leader. However, our ideal time to buy will be
when the company is beginning to actually mine the project, not any time before
that. Do we think that the stock has upside potential, of course! This will be
due to earnings increasing as a result of their expiring long-term contracts
which are grossly under the current long-term market price. I do suspect
however, that SXR (now named Uraniumone, but we are using the ticker symbol
here) will overtake Cameco as the most profitable uranium pure play miner in the
next few years. The Cigar Lake news seemed to be priced pretty well into
Cameco's share price, however the general market seemed to have been caught off
guard. It allowed for a very interesting correction in valuations as Cameco
stalled out, and the newer producers and future potential producers zoomed
ahead. It must be noted that SXR and DML led the way upwards from the early
morning, and it is only a matter of time before they begin to catch the eye of
Wall Street.
We were one of the first people to say that uranium could
go to $500/lb., as it was still economical at that price but said a realistic
top could be the $400/lb. level as it would still allow for profits from the
huge capital requirements for the plants. We took some ridicule for that
prediction, that is until others (who admittedly are and were more established
began beating the drum to $500/lb. uranium, and even $1,000!!!!) came on board
and the price rose from $50 to $130 over the past few months. Our next idea is
not that ground breaking or even going that far out on a limb, however we
foresee a boom cycle in the commodities sector for years to come. Why do we see
this? Well, probably because the companies see this although Cameco management
would have you believe otherwise. With the most recent merger announced, Rio
Tinto will purchase for $43 Billion, Alcan, the Canadian aluminum concern who
was in search of a white knight in order to fend off Alcoa (the world's second
largest concern). Now usually white knights need not worry about dramatically
outbidding the unwanted suitor, but Rio bid up 38% higher the buying price for
Alcan, thus chasing away Alcoa. Oh yea, and did we forget to mention it was an
all cash deal? Add all of this together and one can understand that Rio's
management believes that they can make this acquisition work, and work very well
in the short term as well. After all, if you use your own cash to do a deal
rather than stock, one has a reasonable expectation that the cash will be
replaced within the near future. Mining stocks have further to go, as do uranium
stocks. In the next 3 years we should expect Rio and BHP to move into the
uranium sector in a big way, and as only these two companies could.
At this time we are still bullish on SSE (although playing
it through their merger partner Universal Uranium), MAW, and adding Continental
Precious Metals (CZQ) to our portfolio at the current price of C$2.83.