From Patrick Ceresna - I had a chance to talk with Rick Rule of Sprott as part of our Macro Voices series and wanted to highlight a few of the interesting parts of the interview for the Inside Edge. At the start of the conversation Rick pointed out the unusually cyclical nature of resource investing:
“…during periods of time when mature natural resource companies appear cheap (that is their enterprise value relative to their EBIT is low), they normally correspond with periods of very high commodity prices. Meaning that the price of the commodity is about to go down, so that the free cash flow is about to go down, so that the debt is about to go up.
When, by contrast, mature natural resource companies seem expensive on an EBIT to enterprise value basis, it’s normally when commodity prices are low. Meaning that cash flow is going to get higher and debt is going to get lower.
In truth, in the 40 years that I have been involved in the game, one looks first for commodities where you believe that ongoing demand for five or ten years is assured, because of the utility afforded by that commodity to society. That is where ongoing demand is assured. Where the price of the commodity – the price that the commodity sells for worldwide – is below the median cost of production.
In other words, you buy the best producers in industries that are literally in liquidation. What that means is that you have a circumstance where, either the price of the commodity goes up, or society does without the commodity. In terms of the broadly traded commodities, the truth is that our way of life depends on commodities. And I would suggest that that’s what sets apart the resource business from other businesses.”
Later I asked Rick what is the opportunity in terms of the investment landscape, relative to uranium?
First of all, you have a commodity that is priced currently at about $23/lb. That costs about $60/lb to make. So, the industry is losing about $35/lb. And, of course, being miners, trying to make it up on volume.
We are seeing supply destruction in the uranium business right now, which is always what you look for. The industry is in liquidation. And, despite what some detractors might say, demand for uranium is assured because people around the world want the lifestyle that you and I enjoy. And doing that is energy-intensive.
With regards to supply, two issues. One you talked about is the down blending of nuclear weapons. Thankfully, this is a theme that has been happening since 1992. And something that continues. The inventory of nuclear weapons, relative to the fuel needs of a world that churns uranium into watts, is fairly small. So that inventory is manageable.
Most of the inventory in the uranium business comes about as a consequence, in the very near term, of the shutting down of nuclear power in Japan. The most important thing to note in the near term – that is the next two or three years – with regards to uranium prices, is simply the pace of Japanese restarts.
And, hence, is this an investable theme? I recently turned 65, which means as an investor I’ve now gone through nine five-year periods. And it turns out that a five-year period for me is much shorter than it might be for other people.
If I believe that an increase in the uranium price to a level that covers the industry cost of capital is inevitable – meaning that, for sure, the uranium price will escalate from $25/lb to at least $60–$65/lb – And it will do so within five years (but much more likely within three and a half years).
That escalation in uranium prices, if you look at the impact that that would have on the balance sheet and the income statements of the small number of uranium producers that continue to exist in the world, means that, for me, this is a very, very investable theme.
Increasingly, of course, we are dealing with investors or speculators who have trauma holding stock over a long weekend, because of some aspect of technical analysis or something that Trump might do. Or simply because they are governed by investor expectations that in turn govern their quarterly bonus.
For me personally, I intend increasingly to invest in circumstances where the answers to the questions begin with “when” rather than “if” an event is going to occur.
And I very much believe that the world is going to continue to demand electricity. And some parts of the world are going to demand baseload electricity, which is delivered cheaply and efficiently.
And $60/lb is the number that is required to produce uranium on a global basis, including sustaining capital costs, prior year write down, costs of capital, stuff like that. Therefore, from my viewpoint, will the uranium price escalate from $25/lb or $22/lb, or whatever it is, to $60/lb? Yes. That’s a “when” question, not an “if” question.
So, for me, it’s a very investable theme.
As far as I am concerned, Rick is right on the money, the question is how does one profit from the opportunity. This is all about time horizon and implementation. The easy thing to do is to buy some of your favorite uranium names in your brokerage account, but one has to put into perspective the 3-5-year time horizon. Personally, I like to utilize option strategies to define the trades, but to do so there are very few uranium stocks that give long term options. For an active investor such as myself, there are really no uranium alternatives to trading Cameco. Being the largest uranium company in Canada, it has the liquidity and options for me to play the story.
The best part, it is available on the NYSE and on the Canadian TSX, including a reasonably tradable Canadian options market. This gives many of the Canadian listeners a number of choices, including the trading of this opportunity in registered accounts like RRSPs and TSFAs.
Thanks for reading.