David Skarica, founder of Addicted to Profits, says another-bigger-graphite bubble is likely on its way. In this interview with The Metals Report, Skarica compares the graphite space with the rare earth and uranium arenas, making some interesting conclusions about what kinds of stocks perform best during market-wide roller coaster movements. However, he warns that the graphite space is different, with no clear industry leaders and a number of companies with high potential. His conclusion? Choose carefully.
The Metals Report: Graphite is a commodity that investors have a tough time pricing. Where do you go to get graphite price information? Or does the price even matter?
David Skarica: With graphite, you have to look at the big picture story. There is no exchange-based market. There is no graphite traded on London Metals Exchange. Instead, you have to understand the long-term, underlying fundamentals and the supply/demand picture. The demand picture is this: A lot of high-tech products use graphite-especially rechargeable batteries for cars and electronics. In addition, carbon fiber is a source of demand because a lot of cars in the future will use carbon fiber to save weight. The new Boeing 787 jumbo jet uses significant carbon fiber to reduce weight and save on fuel. Carbon fiber is used extensively in military equipment. Demand for carbon in these unique applications will be growing.
The supply of graphite is dominated by China, which controls over 70% of the world market. There is a risk that China will remove some export graphite from the market. This is similar to the situation that has already happened with rare earth element [REE] supply. Similarly, Russia has a dominant position in the palladium market and can use that position to suit its strategic and business goals. China may try something similar with graphite.
TMR: Rare earths can't be synthesized, but graphite derivatives like graphene can be made synthetically from fossil fuel carbon sources. Is that a concern to you?
DS: It's not a huge concern. Even if synthetic graphite supply increases, there's a certain elastic demand for the products that graphite is used in. We all thought that if oil got high enough, we might be running our cars on natural gas, and that hasn't exactly happened. On the other hand, the European Union and the U.S. have stated that graphite is a strategic material for national defense. We are seeing increased graphite production in the U.S. and Canada as a result. That's another reason to be bullish on the sector. Solid demand and limited supply is creating bullish pricing fundamentals. Even if the price dropped 20-30% from its current levels, it would be economic to produce in most cases. Every country wants to produce more graphite. If graphite becomes more strategic, governments could buy it directly from the producers. There are a lot of reasons to like the graphite story right now.
TMR: Everything you said makes sense to me. It probably made sense to a lot of other people two years ago. That's why we had a hot market in graphite stocks a couple of years ago. What is different now?
DS: It's still very early in the graphite market. I call these mini-bubbles or maybe a prelude to a bubble. We saw this in uranium in the mid-2000s. In that market, former gold stocks would rebrand themselves as uranium explorers and some went up tenfold. Graphite probably will turn into a bubble. Even though I'm talking about these long-term fundamentals, investors will probably want to sell their graphite holdings in two years. Even though the long-term fundamentals are going to be good for five, 10 or 15 years, you may never see the prices of some of these companies hit those highs again. Even uranium companies had these big, 100%+ run-ups, then corrections of 40, 50 or 60%. Then the stocks would bottom and you'd have another big run-up. You're probably going to see a few of these types of run-ups in the future.
Keep in mind that you have to be very selective with graphite. First, most of the companies are not big companies. Second, there are quite a few companies that have a realistic shot at production. For investors, I consider it a better playing field than uranium was in the mid-2000s. The uranium market had far higher barriers to entry because of the cost of uranium mine building and regulation. In this way, many of the graphite companies are much more realistic. Right now, most graphite names are still cheap, being priced at the same depressed levels as the rest of the mining industry. The risk-reward is positive at the current level. You just have to do your research, find a couple of solid companies and then go from there.
TMR: Besides graphite, you are interested uranium. What do you like about uranium in 2013?
DS: Uranium is interesting because we know where it is in the cycle. Uranium is post- bubble. Even with the Japan crisis, the fundamentals are good for uranium. Is demand going to kick down a little bit? Yes. Germany is getting out of nuclear production. But there's a new government in Japan that says it's still building new nuclear power plants. The long-term fundamentals are bullish. China and India are building power plants. The price chart tells a bullish story for uranium.
Cameco Corp. (NYSE:CCJ) has been basing between $16 and roughly $22 for the past year or so. This is called a phase 1 base. Usually, this base is followed by a long, large move higher. I am looking for something like that from Cameco. The reason that I focus on Cameco is that it is the bellwether for the industry. For most people, Cameco provides enough sector exposure.
TMR: Are there any other stories that you think investors should consider?
DS: If you like the rare earth story and want a simple way to play it, Molycorp Inc. (MCP) is an excellent way to play it. Molycorp fell from $70 down to a low of $6. It's about $9 right now. It's one of these maximum pessimism plays. It's a nice way of playing the alternative metals with the market leader-albeit in a relatively small market.
This brings us back to an issue in the graphite market. In the REE sector, we have Molycorp as the market leading stock. In uranium, we have Cameco as the industry bellwether. Both are highly liquid stocks traded on the New York Stock Exchange. However, in graphite, we have several smaller companies to choose from and no clear market leader, and certainly nothing with the market liquidity of Molycorp or Cameco.
When looking at the maximum pessimism trades, it gets to the point where even industry-leading large caps get extremely depressed. Under those conditions, if you see solidification in demand for their commodities, then share prices and the broader market could turn around. That could make Molycorp a five- or six-bagger, with Cameco potentially a three- or four-bagger. So you have the potentials for big gains in well-financed large companies that you know aren't going under.
TMR: Producers with real plant and equipment, huge deposits and a track record.
DS: In 2001-2002, you could buy a lot of these big-tier producers, like an Eldorado Gold Corp. (NYSE:EGO), which was trading at $0.25-0.50. In 2000-2001, there was really no point in buying juniors. You should have just bought the producers. They were all really cheap. Then when they had their first move, from late 2000 to about early 2003, then you could have shifted that money into the juniors, which were just starting to move. When markets are depressed, it is best to buy the seniors, and you can just feel your way around. If things solidify, and it looks like there's more demand, then you go into the juniors.
But it may take a long time for the uranium and REE bubbles to re-inflate, and it's not a given they ever will. In that case, many or most of the juniors will simply not come back. How many of the smallest startups came back from the dot-com bubble? Many of the best-performing tech companies recently were companies that emerged after the tech bubble. The obvious example is Apple, which did nothing in the 1990s. Many of the biggest names in tech didn't even go public until after 2000. Google is an example. It's the same thing in uranium or REEs. If you invest in junior uranium or rare earth companies now, they might not exist in the future. There might be new initial public offerings that come out.
TMR: Any closing thoughts?
DS: I believe that graphite is a legitimate story that will turn into a legitimate boom. The best part of the graphite story is while there is a dearth of quality companies, there is a number of companies that will realistically become good, profitable producers. This is unlike the uranium equity market of a few years ago, when most of the companies were going to go by the wayside.
The graphite story has a long way to go. If the re-inflation trend starts because of Japan, Europe and the U.S. printing money, then that is just one more tailwind pushing the graphite market higher. The same macro trends apply to the large caps in uranium and REEs, like Molycorp and Cameco. At today's prices, they represent good value. They've fallen between 60-80% from their highs, they're very depressed and they have good potential to be turnaround plays, if re-inflation kicks in.
TMR: Thanks for your analysis; it has been interesting.
DS: My pleasure.
At the age of 18, David Skarica became the youngest person to pass the Canadian Securities Course. He is the author of Stock Market Panic! How to Prosper in the Coming Bear Market, The Contrarian Who Saved the World, and The Great Super Cycle: Profit from the Coming Inflation Tidal Wave and Dollar Devaluation. In 1998, he started Addicted to Profits, a newsletter focused on technical analysis of markets.
1) Alec Gimurtu of The Metals Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: Eldorado Gold Corp.
2) The following companies mentioned in the interview are sponsors of The Metals Report: None. Interviews are edited for clarity.
3) David Skarica: I personally and/or my family own shares of the following companies mentioned in this interview: Eldorado Gold Corp. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.