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A mineral that has been steadily gaining buzz in the resource sector is graphite. In this post we'll take a look at the supply/demand factors as well as some stocks that offer an opportunity to play graphite. Personally I do not own any graphite stocks, and remain more focused on gold and uranium, but I am monitoring the sector for opportunities that come via new listings and sharp sell-offs.

Supply and Demand in the Graphite Market

This article by Rick Mills offers an excellent introduction to the supply/demand situation in the graphite market. To summarize:

  • Current market demand is 1 - 1.2 million tons per year
  • China, India, and Canada are the major producers, with China currently producing over 70%
  • As is common with many other minerals, the shift in the energy paradigm is driving new demand in the graphite market; graphite is essential for new fuel cell technologies and for use in nuclear reactors. These new factors could double demand for graphite by 2020.
  • A European Commission study in 2010 listed graphite as one of 14 materials that was both high in economic importance and supply risk. The US State Department and Department of Homeland Security have also listed graphite as a critical material.

Here we see parallels between graphite and rare earths (NYSEARCA:REMX), which enjoyed a bubble in 2010-2011. Rare earths are also used in many emerging energy solutions, current production is controlled largely by China, and the supply/demand imbalance is growing. From this perspective, I do not think it is unreasonable to think that what happened in rare earths in 2010 and the first quarter of 2011 will occur in graphite some time in the near future -- especially when we consider that monetary policy remains especially lax, and thus conducive to bubbles forming somewhere, and that a weak bond market yielding zero or negative returns may lead to a further influx of capital into equities.

Quick Picks for Playing Graphite

Being a newcomer to any market always involves a steep learning curve in mapping out the value network and the strategic paradigm, but something that should make due diligence and investing easier is that the market of publicly available graphite companies is still quite small. Here is another similarity we see with rare earths; there wasn't much in the rare earths sector besides Molycorp (MCP) that was easily accessible to most North American investors, so that stock soared in 2010 and those who knew there was an opportunity brewing in rare earths did not have too many options to sort through. The same is currently true of the situation in the graphite market.

Here are a few stocks I've got on my radar in the graphite sector:

China Carbon Graphite Group Inc (OTCQB:CHGI)

A market cap of just $20 million instantly positions this graphite developer as a high risk/high reward opportunity. CHGI does have positive earnings and a P/E ratio of 20.37 at the time of this writing. Its position in Mongolia leaves the company well-placed to participate in China's aerospace and nuclear industry, both of which will require graphite. The firm does have international clients outside of China and Mongolia, and its management does boast higher degrees from US institutions like Columbia University and Oklahoma State. CHGI is currently trading at $0.84 and is already up more than 50% this year, although it is still well-below its 2010 highs of $3.12 per share. If a graphite bubble emerges, I think a re-test of all-time highs is quite possible -- especially if the company continues to operate profitably.

Graftech International (GTI)

A quick look at the numbers leaves me with a very favorable impression of Graftech: a P/E ratio of 11.43 is low enough, and a market capitalization of $1.73 billion is the kind of size I like: not tiny enough to be crushed overnight, but not too big to succumb to the law of large numbers. The company boasted record sales in 2011, deriving approximately 80% of its revenue from industrial steel uses with 20% coming from the emerging engineered solutions largely related to new energy and transportation needs. The company has been around since 1886, and was founded in Ohio, USA where it remains headquartered. The company is currently trading at around $12, near its 52 week low; its 52 week high is $23.63, nearly 100% higher. If a bubble comes into graphite, I think this stock could do very, very well from its current price.

Focus Metals (OTCQX:FCSMF)

I owe a debt of gratitude to Focus, because it is the first company that got me interested in graphite. The company understands the graphite market very well and is a miner operating out of the Labrador Trough in Canada -- an area I find to be very favorable for mining, as I previously noted in my article on Altius Minerals. Focus is up over 30% on the year, and it currently has a market capitalization of around $75 million. Focus is more of a mining play, rather than an engineering play, which may be favorable for those coming from elsewhere in the resource mining sector.

Northern Graphite Corporation (OTCQX:NGPHF)

Northern Graphite is a miner that is up over 100% on the year thus far. Given that it trades at $2.10 now and still has a market cap of just $78.10 million, though, I think it is quite conceivable that the stock can go higher. The company is still in the exploration phase; it is slated to start production in Q3 of 2013. Small cap explorers are amongst the highest risk/reward plays out there -- so extra caution is needed, as well as the discipline to be patient and wait for dips. Personally I don't think I'll buy any Northern Graphite unless there is a big sell-off that brings price down significantly.

If a bubble does emerge in graphite, it is a reasonable expectation that charlatans and reckless gamblers will come into the market as well. Proper due diligence can help you avoid the charlatans, while discipline and money management can help you avoid the temptation to engage in reckless gambler. For the astute investor who understands the supply/demand imbalance and the graphite value network, I do think there could be some outstanding opportunities. In hindsight, I should have included graphite in my list of potential bubbles.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.