Warning: Uranium To Explode

Uranium mining equities have made for a poor investment over the past decade as uranium prices have remained below the world average cost of production. In 2011, uranium was $55 per pound, today that figure has fallen to $25. Interestingly, at one point in 2007, the green metal was worth $140 per pound during the peak of the “Uranium bubble” when it was worth merely $10 per pound five years prior. This is important because it shows how easily the small global uranium market can become severely disconnected with its economic fundamentals. Inefficiencies are large if you look in strange areas of the globe.

Despite the decline in uranium prices, global demand for uranium has been rising steadily as India and China have opened 22 and 46 nuclear reactors. Despite a temporary pause following events in Fukushima, there are currently 53 new reactors under construction which will increase demand by at least 10-15% over the coming six years (the average construction time).

When prices are low, world governments see opportunity for cheap nuclear energy and build more reactors. However, as you know, those plants must buy uranium at no matter the cost, so a supply shortage could cause uranium prices to, dare I say it, “Go Nuclear”.

Uranium Prices Starting to Rebound

Using the 2011 $70 peak as a benchmark (it is safe to assume the 2008 peak was purely speculative), the metal bottomed out 71% lower at $20 per pound last year and has begun to slowly rise higher.

Here is a chart of the price per pound:

Source: Trading Economics

While the current trend is still in its infancy, it is just at the point where I’d like to buy. The trend is apparent but also far from being noticed by fellow speculators, so it is likely that many buyers are still waiting on the sidelines or have forgotten.

$30 is the key level, it is EIA’s estimated average global uranium cost of production, so if prices manage to get to that level, uranium producers will likely turn a profit and see rapid appreciation. Further, if that level is rejected again, then it is likely producers will slip even lower.

Supply-Demand Fundamentals Support Upside

According to the World Nuclear Association, the current operable global reactor energy capacity is 394,000 MWe while there is another 53,3000 MWe soon to be added due to new reactors. Here is the geographic breakdown of current and new capacity:

Source: World Nuclear Association

That is not all, there is also an additional 67,000 MWe in plants that have not begun construction but will over the coming years and an additional 300 more reactors have been proposed. In total, this means demand for uranium may double by 2030.

To make it even better, there is already a roughly 90 Mlb supply shortage in the market as there are roughly 160 Mlb in production and 250 Mlb in consumption per year. During the heights of the cold war, production of uranium was far higher than consumption and resulted in massive reserve buildups that have been slowly depleting.

Here is a supply and demand chart:

Source: BMO’s U-Turn: Uranium Thematic Seminar

Those reserves are difficult to quantify as governments and other controlling entities keep their inventory a secret. This comes primarily through dismantling of military warheads and civil stockpiles. It is difficult to estimate how long it will take for those inventories to be depleted, but with quite a few new reactors coming online this year and a shortage being expected by BMO, it may be a good time to bet on it.

Remember, nuclear power plants cannot halt production easily if prices rise, they are a forced buyer. With prices at their current levels, very little new production is being added and many mines are being forced to shut down. As an example, the United States used to produce 45 million pounds of uranium in 1980, today, it only produces 1.4 million pounds.

Source: EIA

If trends like this continue, then the above production estimates may even be too high. The reality is that it is very difficult for miners to make a profit in developed economies. Today, Kazakhstan produces nearly 40% of the global supply of uranium. That country has seen its GDP per capita rise from under $10,000 in 1998 to over $25,000 today on a PPP basis. Kazakhstan is just one example of many that highlight that cost of production will continue to rise in emerging markets and inevitably be one more factor pushing prices higher through supply shortages.

Overall, the fundamentals are supportive of a long-term bull market in uranium. It is too early to say if that bull market will begin immediately. But, it is safe to say that it will happen over the coming years unless another unfortunate event like the Fukushima disaster occurs that slows Asia’s construction.

Enter the URA ETF

One enticing way to bet on the coming supply shortage is through the Global X ETF (URA). The fund invests in companies involved in uranium mining and the production of nuclear components. The fund has an adequate AUM of $192M and an expense ratio of 0.7% compared to its yield of 1.4%. It has very high volatility of 32% and a Beta to the S&P 500 of 0.9, so it is certainly a “high risk high reward” type of product.

Following the recent turmoil in equity markets, the URA ETF broke below the support level it had in place since 2016. In my opinion, this has called for a serious buying opportunity as those equity prices are supported by improving fundamentals.

Source: Trading View

It appears that long investors have recently capitulated as you can see steady declining volume since 2017 followed by a small rise in negative volume. I view this as a signal that many have given up on the fundamental “long-term steep supply shortage” narrative and have likely caused short-term short sellers to enter the market.

Risks and Rewards

It can be dangerous to try to catch a falling knife. This is why our new long URA position is done through short-term covered calls, this allows us a buffer if this current breakdown continues and lets us take advantage of its implied volatility spike to 30%.

Most of the company’s in the ETF are trading at or around their book value, so we would be surprised by significantly more downside. That said, if global equity markets continue to turn for the worst, then valuation metrics go out the window and everything falls. That would certainly make for an exciting fire-sale, but it would also be unfortunate for investors.

Another risk to consider is the risk of a black-swan event like Fukushima or 3-Mile Island. Of course, it would be nice to think that the world is past tragedy’s like that, but happened in 2011 and caused the URA ETF to fall nearly 40% in a matter of days.

Over the long-run and even in the short-run, URA looks like a solid opportunity. The fundamental story is relatively unknown by the wider investment community and technical signals, as well as new reactors, indicate that they may hear about it soon. Nuclear power has come back into vogue, but few new mines are being created. We will certainly be keeping a close eye on this story in months to come.

Source: Seeking Alpha