“Pictures could not be accessories to the story -- evidence -- they had to contain the story within the frame; the best picture contained a whole war within one frame." -- Tatjana Soli, The Lotus Eaters
07/19/2019
I’ve been wanting to write more about our steadily increasing uranium position for a while. Recent events have moved that timeline up. There were some dramatic moves in several uranium stocks on July 12th as the Trump administration ruled on a pending request for uranium quotas. First, some background. Two U.S. uranium mining companies filed a petition in January of 2018 to request that U.S. utilities be required to purchase at least 25% of their uranium from U.S. companies. The Trump administration had until July 13th to rule on the issue.
There was some logic behind the requested quotas. Uranium is strategically important to the country given that 20% of our electricity is generated by nuclear power, and our military and national defense are reliant on uranium supply. We once were able to supply 100% of our uranium needs domestically, but we currently import 93% of our commercial uranium. Domestic uranium mining has been long-neglected and uncompetitive with subsidized foreign competition, leaving the industry hollowed out. While our ally Canada is a key supplier, we’re also dependent on state-subsidized supply from Russia, Kazakhstan, and Uzbekistan to meet 40% of our needs. The petitioners argued that a 25% quota would help revitalize domestic uranium production and reduce reliance on imports and foreign adversaries. It wasn’t a crazy request.
U.S. electric utilities that operate nuclear power plants, however, were strongly against quotas as it would increase their costs and impose additional procurement and documentation burdens on them. Although nuclear fuel (uranium) is a very small portion of the cost structure of a nuclear power plant, it’s no surprise that these businesses were lobbying against higher costs and more regulation. It wasn’t a crazy objection.
Given Trump’s inconsistencies on various trade issues, it was never clear how his administration would rule. News of a decision was first leaked on the 12th by a credible Australian publication, which was a bit odd. I still haven’t seen a good explanation as to how an Australian publication caught whiff of this first. Regardless, the leaked news was that Trump was going to reject the quota request. There are only a few public, U.S.-based, uranium mining companies, and their stocks were summarily trashed once the news leaked. Conversely, the stock prices of foreign uranium miners were immediately bid higher. Later in the day, the leaked news was echoed by a couple U.S. news sources. The stocks of the two petitioners were absolutely nuked (that was too easy) during the day, falling over 30%.
We’ve been systematically building a position in the uranium space this past year. We’ve intentionally built this position slowly as the catalysts for a big move higher have also been gradually building. In addition, some of the names we’ve been buying aren’t liquid, meaning they’re difficult to trade without moving the price. It’s taken time to build up our holdings. Finally, we’ve built up our positions methodically precisely because of this pending quota request.
This quota request was never a part of our bullish case for uranium. In fact, I’ve viewed it as more of a nuisance since it introduced unnecessary uncertainty to an already suffering industry. Utilities have understandably been hesitant to enter into long-term contracts for uranium since they haven’t known if they’d be forced to shift some of their uranium purchases to higher-cost U.S. producers. We’ve made no bet on the outcome of this quota petition. We’ve simply wanted a decision so the industry could move forward with more clarity. As for the stocks, it was clear that any ruling would benefit some mining stocks at the expense of others, at least in the short term. As a result, we’ve very intentionally been building a diversified basket of both U.S. and foreign uranium plays with the intention of taking advantage of any dramatic moves resulting from a ruling.
We did, in fact, get that dramatic move in prices on July 12th, much more so than I expected. It’s clear, with hindsight, that short-term traders were heavily betting that quotas would be approved. As news leaked that Trump would reject the quota request, these speculators rushed to dump shares of the U.S. producers. With no official news out from the administration, few natural buyers of uranium stocks were eager to step into the void and catch these falling knives.
I did say “few”. We viewed this sell-off as a gift. The petition had no bearing on our bullish uranium thesis, and its resolution is ultimately a positive for the overall sector. A 30+% haircut on the domestic players was an overreaction, in my view, so we happily took advantage of the discount and the liquidity to top off our uranium holdings. I don’t like to predict the timing of major cycle turns, as you know, but dramatic sell-offs and blow-off rallies often mark bottoms and tops.
Following the close of the market, the administration released its official response, and, as expected, they ruled against quotas. However, the ruling did establish the United States Nuclear Fuel Working Group to “develop recommendations for reviving and expanding domestic nuclear fuel production.” The Group is to “examine the current state of domestic nuclear fuel production to reinvigorate the entire nuclear fuel supply chain, consistent with United States national security and nonproliferation goals.” Trump gave the Group 90 days to submit their report and make recommendations “to further enable domestic nuclear fuel production if needed.”
The administration is pro-nuclear, aware of the supply issue, and interested in supporting the domestic industry. Even if the administration only helps the nuclear utilities, this is ultimately good for the uranium miners since more nuclear power generation means more uranium demand. The only catch is that we have another window of uncertainty now as utilities may reasonably hold off on buying uranium a bit longer until they see the recommendations of the Working Group and possibly any subsequent decision by the administration.
Now
that you’re an expert on Section 232 uranium quotas, feel free to forget all about them. It may have been important for short-term gamblers betting on Trump’s decision, but it has no bearing on our bullish uranium thesis. It may have delayed the uranium bull market these past 18 months (and perhaps a few more), but it has no impact on the global supply and demand story or on how high uranium prices will ultimately rise. Moving forward, electric utilities are now going to be more willing to enter longer-term uranium contracts, which they must do over the next 2-5 years given inventory levels and the nature of the fuel cycle.
The chart above shows the 50-year history of uranium prices, both nominal (not adjusted for inflation) and real (adjusted for inflation). Recent lows in the price of uranium match the inflation-adjusted lows of 2000. We waited to start building our uranium exposure until prices had fallen nearly 90% in real terms from the 2007 highs. We’ll see in time if the next uranium bull market results in a spike like 2007 or 1976, but our thesis doesn’t depend on it. Given the cost of production and growing demand, uranium prices are likely to double or triple in the coming years, barring a Fukushima-type event. This would result in tremendous gains for the uranium miners.
I’ll have more to say about uranium in future pieces. For now, let me be very clear that I like this play at least as much as I like the precious metals thesis, and you all know how bullish I am on that space. One of my favorite investment themes is to invest in a commodity that is trading below the cost of production, that is currently undersupplied, and that is experiencing shrinking supply and rising demand. These are “when”, not “if” investments. Higher prices are ultimately the cure for bringing much-needed supply back online. The only issue is how long the buyers of the commodity can live off current inventories before bidding up future supply and how much future supply will be available at each higher price level. Uranium today has one of the best setups I’ve ever seen. While most investors are still enamored with the grossly overvalued tech sector, money-losing private equity companies, negative-yielding debt, and scandal-ridden cryptocurrencies, the neglected and unloved uranium sector offers one of the best risk-return trade-offs I’ve seen in my career.
Best,
Ken Bell, CFA, CFP, MBA, Yellowcake Hoarder
Aspera Financial, LLC
The Market Rubbernecker is associated with Aspera Financial, LLC, an investment management and financial planning firm based in the Cary, Raleigh, and Durham area of North Carolina. This and all Market Rubbernecker missives and musings (written, oral, or mimed) are subject to the disclaimers, disavowals, and hindquarter-coverings found at www.asperafinancial.com/aboutrubbernecker.