For those following commodities, a resurgence with respect to commodity prices were seen in 2010. This has been important for several reasons. First is the economic rebound. After an economic slowdown, basic materials will be one of the first sectors to see a comeback. As demand increases for products, a draw down of inventories lead to purchases of the raw materials used to make those products. The second will be seen as more of an opinion than fact, but there was an interruption of the world wide commodity bull run.
In August of 2009, The Energy Report interviewed Carmel Daniel (CEO and CIO of CD Capital). She stated that the world economy had started a commodity super cycle in 2006. This cycle was interrupted when Lehman and others collapsed. She appears to have been correct on her assumption. Most commodity super cycles have lasted 20-30 years. In 1880, it lasted 30 years with the urbanization of 100 million people. After WWII there was an urbanization of 30 million people, which lasted about 20 years.
She hypothesized the current cycle involves 3 billion people in China and India, and thinks it could last another 20 years, based on the sheer number of people involved. She believes commodities could continue to run for two reasons.
The first is population growth. In 2008 there were 6.5 billion people with 3 billion in cities. In 2030, she estimated the world's population would grow to 8 billion with 5 billion in cities. For this reason she likes fertilizer, specifically phosphate and potash. We are just beginning to see she is right. Phosphate is a specialty of CF Industries (NYSE:CF), and the company has had a very nice run over the past few months. Potash has also done well, specifically those that produce potash used in higher end fruits such as (NYSE:SQM) and (NYSE:CMP). Other potash companies to consider are Potash (NYSE:POT), Intrepid Potash (NYSE:IPI), Mosaic (NYSE:MOS), Agrium (NYSE:AGU), and Terra Nitrogen (NYSE:TNH). Currently momentum seems to be with CF and SQM.
The second reason to like commodities is infrastructural spending. Emerging markets are seeing trade surpluses, and they are trying to put the money to work. With their citizens moving from rural to urban areas, there is a much greater need for energy, food and roads.
Daniel also stated that there will be a need for lithium. Lithium is an interesting metal as there are no replacements. Lithium is important with respect to laptop computers, handheld devices and automobiles. There has been some talk of rechargeable aluminum batteries, but this doesn’t seem to be something to worry about for years. SQM has an advantage here as the company is a low cost producer of lithium.
Eric Linser highlighted the importance of SQM's Salar brines leached from the Andes Mountains here. Not only does SQM have the largest deposit of lithium known, but it is a cheap producer. Another way to trade lithium is through the ETF LIT.
More information on lithium can be found here. This article addressed an issue that is developing; where the world would like to decrease the use of oil to power vehicles for lithium (hybrids). As the world begins to use more oil than can be produced, lithium batteries will store electricity to propel their vehicles, with gasoline being a backup if the battery runs low.
If this is the case, power plants will provide much of the electricity as we begin to plug in our vehicles as opposed to filling the tank. Coal has been the story to produce electricity, but this momentum is changing, as people are realizing other means will need to be used for power. Countries like the U.S., Russia and China have used coal as both countries have a very large supply. Many countries are beginning to look to uranium as a way to provide cheap electricity and to work in concert with coal and natural gas. Uranium investment can be difficult for the average investor, as there are several names listed, but many are not producing or are losing money. The recent move in the spot price from $40 to $60/lb. shows increased demand as countries are trying to shore up inventories while they can still be purchased cheap. One pound of uranium produces the same amount of electricity as 20000 lbs. of coal.
For those that are not interested in uranium producers that are speculative, or do not currently produce, here is a listing of the top ten companies of production as provided by Paladin's (OTCPK:PALAF) last annual general meeting.
Cameco (NYSE:CCJ) is the second largest producer and since it sold off its gold interests, the company is a pure play on uranium. The largest producer is Kazatomprom. Cameco may be the safest play based on their legacy contracts, but will probably not see as large of an upside with the increase in spot price. The company also has very cheap production. Paladin's production in 2010 shows impressive growth from 2009. In 2009, 3.5 million lbs. were produced. In 2010, it was increased to 5.6 million lbs. The company is estimating production of 7 million lbs by the end of 2011. Areva produced an impressive 15 million lbs. in 2009 and 2010.
Lastly, and my favorite, is Denison (NYSEMKT:DNN). The company produced 1.4 million pounds in 2009 and 1.6 million in 2010. It has zero debt and operating capital of $78 million as of September of 2010. In 2010, the company saw large increases in revenue and has cut earnings losses to a much more manageable level.
We have seen a convergence of the spot price to long term price of uranium. The price of vanadium has doubled. When looking at Denison's production growth targets, its timing may be perfect. In 2013, Russia will discontinue its conversion of nuclear warheads to uranium fuel. This is 65% of the world's current uranium consumption. In 2014 Denison's production will increase to 4 million pounds. In 2016 this production will increase to 6 million lbs. In 2018 production will be almost 12 million lbs. Denison states it can increase production to a sustainable rate of 10 million lbs.
To put that in to perspective, as of 2010 that would place Denison as the sixth highest producer of uranium in the world. Also, estimated cost of production for Denison in 2010 of $37.07 per lb of uranium in U.S. dollars. With the current spot price above $60 lb., and previous high at $137 lb. it is conceivable to have a price in the triple digits sometime in the near future.
All said, these commodities could see exponential growth over the next few years. It comes down one basic theme. The countries with the largest population (China and India) are in the process of urbanization. With many moving to cities they will need food and energy. Fertilizer and energy should be the main themes of this process. Since it would be difficult to increase acres of farmland (except in areas such as the Amazon Forest), yield increases will be needed to increase food production. The most cost effective way is with fertilizer. Fertilizer is made of three nutrients: Potash, phosphorous, and nitrogen. The most difficult to increase production is potash as it takes a substantial investment and time. Look to SQM and CMP to be able to increase margins faster as their potash is used in higher margin fruits.
Energy will also be an important theme. Lithium batteries are a way to store energy and use in the new handheld/computer bull run. More importantly, rising oil prices will increase the need for hybrid vehicles where SQM should benefit with LIT being a way to decrease exposure to just one company. Also, uranium has several factors leading to a multiyear bull market. Production being pulled off the market by Russia. China and India buying up excess production while it is cheap. Lastly, there is substantial build in reactors as emerging markets try to meet energy needs. CCJ is the least risky pure play. DNN and PALAD.PK are production growth stories. The speculative play looks to be URG on momentum. If Carmel Daniel is right, these stories are just beginning.
Disclosure: I am long DNN, URG, DAG, SQM, CF.
Additional disclosure: I currently do not own other stocks mentioned, but do trade in and out of some of the other names listed in the article. I also buy puts for protection, and levered ETFs that may include some of the names listed.