U-turn: Uranium Begins Recovery Phase

Excerpts from Hallgarten & Company's recent 'Metals Outlook' report by Christopher Ecclestone:

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The Dynamics of Uranium

It might be germane at this juncture to dwell upon the “metal” before we look at some relatively unnoticed but worthy names that might exploit the current situation. This “metal” bears closest similarity to the “by appointment” iron ore market than to the other publicly traded and liquid metals. The buyers are principally end-users (until recently) and they can easily short-circuit and go direct to the producers. Moreover the market is an extremely sensitive one in light of the other less pacific uses that the product, if enhanced, can be put to. So while it may be opaque as to who is really buying what at which price level, governments are constantly monitoring who has the product and what they doing with it. The product is not exactly a rare one. The fact that Wealth Minerals, a relative junior, can suddenly pop up with nine prospects in a few short months in Argentina shows that uranium is there for the finding and moreover it is not a product with a plethora of uses or consumption in the enormous quantities that other metals exhibit.

The underlying production story is what fed the bullish trend. Current US production is 50 million pounds of U3O8 per annum, however US production is a minuscule 3-4 million pounds form four mills. The substantial shortfall is made up from old Cold War stockpiles (ironically probably including some of the ore from Monaro and UEC’s mines in their heyday). The deficit is not only in the US. In 2006, the global consumption of U3O8 was 160 million and production was a mere 100 million pounds. Clearly such substantial shortfalls cannot go on indefinitely. It is hard to think of another “metal” that has such a “good” (meaning massively unsatisfied) supply/demand prognosis. While Monaro’s mine’s are on a relatively short time frame to production, massive mines to plug that gap would take years to develop. This is just not on the horizon. This is what propelled the price of uranium up, but probably two or three years before the real crisis was to impact.

The revival of interest in uranium, which was largely spurred by the better pricing, has created a new generation of stocks in the sub-sector some of whom will prove to be additions of new resources and genuine producers broadening the number of sources of global supply away from the few mega- producing mines that dominated the scene during the low price phase. Many others will be mere cannon fodder that shall be blown away by the exigencies of Darwinian capitalism. The extinction phase for many of this species is now in full flight.

Uranium Price Trends

The price of uranium doodled about between a high of $17 in 1987 down to $7 in November 2000 before breaching the 1987 previous high in March 2004. The metal started a gradual glide upwards which might have genuinely been reflation-powered but then the riffraff jumped on board in late 2005, buckled their seatbelts and took everyone for a ride.

The ramp out of relative obscurity was a debacle that could have easily been foreseen. One look at the dubious quality of those touting its virtues made clear that it was not a quality game with quality players. When the “ramp and dump” crowd move in then the dump is inevitable and the “metal” had a hefty 30% lopped of its valuation in a matter of weeks as boredom set in and the speculative forces tried to cover their losses elsewhere. It was a classic bear-trap. Its rise had nothing to do with gold, monetary issues or even supply and demand, so that its fall was similarly unfounded and should have come as no surprise.

The price of uranium appears to have bottomed out in recent weeks. The spot uranium price has recovered by $7 in some recently reported spot trades to $64.50 a pound. However the term price for uranium, which is the price most of the utilities pay, has fallen by $10 to $80 a pound - the first such fall reported for an awfully long time.

These are early days yet, but some forces in the market think that the term price may fall further as buyers, primarily utilities, look to contract term deals with a lesser premium to the lower spot price of recent weeks. Rather than holding to a set spread between the spot and term prices more deals will be done using spot, base-escalated prices, or a combination of these.

At current uranium prices this has to perhaps be a negative income-wise for the major established producers but positive for the developing miners and explorers as it suggests spot prices may be beginning to close with term prices. Undoubtedly demand remains relatively high and the spot market Wednesday, September 3, 2008 sellers are reported to be raising prices and being matched by buyers with active interest in material above $60 a pound.

While the recent price rebound is minor, it is unlikely to see a return to the heady days where the word “uranium” in the name of junior explorer meant an almost immediate stock price escalation. But the price, even at these low levels is still several times above the price which prevailed for several years up until 2004 and there's little doubt that the stimulation in exploration activity the big price increase engendered has thrown up some potentially really profitable deposits even at current price levels. Should the latest price move really suggest a bottom then it is probable that there could be some good bargains to be found in some of the juniors with good deposits, a decent cash position enabling them to ride out the recent downturn in interest, and with oversold stocks...

Uranium Energy Corp (UEC)

The uranium mining industry is one of the few areas where the US is up to speed on mining. While Australia and Canada also figure in the production mix these days, the US can still hold its own in uranium mining despite having slipped in almost every other class of mining activity. That is not to say they have the dominance they once did in the 1950s and 1960s. The potential remains for the US to recapture lost ground. As we noted with Monaro, the US has mothballed mines and extensive past exploration data that make it that much easier to move the ball forward in this mining province. Surprisingly even the NIMBY factor is scarcely evident, as yet...

Uranium Energy Corp is an AMEX-listed junior that controls one of the largest historical uranium mining exploration and development databases in the US. The company feels that these databases, combined with a strong technical team, have been key in helping them acquire advanced uranium properties throughout the southwestern US.

UEC has “focused” its property acquisition program primarily in the southwestern US states of Texas, Wyoming, New Mexico, Arizona, Colorado and Utah. The company has a proliferation of sites, some may say too many. This region has historically been the most concentrated area for uranium mining in the US. With the use of historical exploration databases, Uranium Energy Corp has been able to target properties for acquisition that have already been the subject of significant exploration and development by senior energy companies in the past. The list of past owners reads like a Who’s Who of US energy. Some have faulted this strategy on the grounds that “these experts have worked these over so there must be nothing there”. This is extremely fallacious as it fails to put into context the wholesale exodus of majors from the uranium hunt over recent decades in the face of woefully low prices and the general fall from favor of uranium.

Despite this surfeit of prospects, the company has of late focused on less than a handful. While it has extensive data on most these historical results are largely not up to 43-101 standards. However the company has in hand 43-101 reports on the Goliad prospect and strong historical data on the 49%-owned Cebolleta project showing resources of 6.9 mn lbs and 10.1 mn lbs (UEC’s share) respectively. The active drilling campaign is now focused on the 100%-owned Nichols Project in Karnes County, Texas. The plan calls for 30 exploration holes for a total of approximately 18,000 feet of drilling. Permitting has been submitted and approved by the Texas Railroad Commission’s Division of Surface Mining. Development of the Nichols Project is consistent with the stated plan to establish satellite facilities for the advanced Goliad ISL (in situ leaching) project.

The draft mine permit has been issued for Goliad under an ISL mine plan. The company has drilled over 599 confirmation and delineation holes from May 2006 through December 2007 on top of the 479 holes drilled by Moore Energy in the 1980s. This work produced a 43-101 compliant resource of 6.9 million pounds U3O8, of which 5.4 million pounds is measured and indicated, and 1.5 million pounds is inferred. Moreover the mineralization remains open, laterally, in all directions giving the possibility of further resource expansion. The uranium is in sand horizons at depths of between 90 to 450 feet. The average thickness of these is 14.5ft with an average grade of 0.075%. Testing has indicated good recovery rates of 86-89%. The thickness compensates for a grade that could be more to our liking. The sheer volume of the resource is extremely encouraging and the amenability to ISL lowers the eventual extraction cost and reduces ramp up time. Plans are to begin production by the first quarter of 2010.

The Nichols Project consists of 900 acres, and is located within the heart of the historic Karnes County uranium mining district. It was originally explored by Texaco Uranium (now ChevronTexaco), and reportedly contains an historic resource (not 43-101 compliant) of 1.2 million pounds of U3O8. The data reviewed to date, including Texaco data, indicates that the historic mineralization lies within the Tertiary Age Jackson Formation, and occurs at an average depth of 440 feet. Reports indicate that Texaco Uranium had planned to recover the uranium at the Nichols site using ISL.

The other project with a well-documented resource is the Cebolleta uranium project of Cibola Resources, LLC (owned 51% by Neutron Energy Inc and 49% by UEC). It is situated in the Laguna mining district, about 45 miles west of Albuquerque in New Mexico. The mineral lease covers about 6,700 acres of privately owned surface and mineral rights and is the site of the formerly active St. Anthony and L-Bar uranium mines. The St. Anthony group of mines, which included two open pits and one shallow underground mine, was operated by several different companies since the discovery of significant uranium mineralization on that portion of the property in the 1950’s. These mines are reported to have produced more than 2.5 million pounds of U3O8, while the L-Bar underground mine produced in excess of 1.75 million pounds of U3O8 prior to shutdown of mining and processing operations in mid-1981.

At Cebolleta, the former project operators, Sohio Western Mining and United Nuclear/UNC Resources, outlined six separate uranium deposits. These are hosted in fluvial sandstones with individual deposits ranging in size from several hundred thousand tons to more than two million tons, and have grades ranging from 0.09% to nearly 0.20% of U3O8. The deposits range in depth from 200 feet to nearly 700 feet. The project is estimated to host mineral resources (not 43-101 compliant) of 12.6mn lbs at L Bar and 8.2 mn lbs at St Anthony giving a total resource of 20.8 mn lbs of which 10.2 mn lbs pertains to UEC’s share of the jointly-owned company.

For us the Cebolleta project of UEC is a project that generates considerable excitement mainly because it has a historical track record of production, like Monaro’s properties. In summary, the Goliad property should start to throw of revenues in the not too distant future, Nichols looks prospective but is definitely a longer lead time, while the Cebolleta project has UEC in the back seat but is on highly prospective, and moreover, proven ground for production...

Potential negatives

The most obvious potential pitfall is the uranium price. As we noted earlier there is a general feeling that the froth has been blown off the beer with the retreat from the highs above $120. If anything the price has overshot to the downside with a discount to contract terms as hedge funds and other speculative forces got left holding the yellowcake. Not a nice situation if you aren’t kitted out for it! We expect the price to fluctuate around in the $60-$90 range over the next few years with a potential for upside breakout should some of the talk of more nuclear power plant building in the West actually show signs of coming to fruition.

The other potential negative is the perennial one of bad markets. We are here at the bad place already. It could get worse, but then again the metals, including uranium, could shake off the financial blues and start marching to the true beat, which is supply & demand considerations. Uranium may be the first swallow of summer in its recent move to the upside after a harrowing ride down. At the moment funding is tough and all the companies mentioned will need to get more financing in place to start themselves on the road to production. The key to this funding being successful or not depends on the uranium price moves over the remaining months of 2008.

Conclusion

Just as the rising tide of uranium prices in the middle of the decade created a plethora of uranium stock IPOs, the receding tide has left many of these names floundering breathless (and cashless) on the beach. The price of uranium seems to have stabilized giving hope that some of the long term fundamental bullish factors for the metal will come back into focus, without the frenzied hype that promoters had previously invested in it.

This new landscape is tough going for the survivors of the shakeout but ultimately the cashed up or those with production shall quite literally “inherit the earth”. Traditional mining investors largely got out of the way when it became clear in 2006 and 2007 that neophytes were rampaging loose in the uranium stock and spot commodity markets. If they did anything, the old timers focused on the tried and true producing names and avoided the proliferating juniors. This implies that there are investors out there who were waiting for the inevitable shakeout and are constantly testing to see if a bottom has been made after the froth has been blown off the spot market. As we have noted, the spot market is scarcely indicative of anything in uranium’s case but it did provide the feedback loop that drove the stock price of the junior miners.

Thus we would divide the uranium juniors into those on the cusp of moving from survival mode into expansion mode while the rest of the pack roam around shell-shocked at the fate that has befallen them. So if the potential survivors are not on the road to annihilation it would appear that their current valuations severely underestimate their potential worth. The grim reaper will carry away the lesser players leaving the playing field clearer over the next 12-months. Money will gravitate to the survivors.

Important disclosures

I, Christopher Ecclestone, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.

Comments

[titans:]

The best growth story of the uranium sector is Paladin Energy from Australia (PALAF)....The 1st company last year to bring a new uranium mine into production in the last decade.With another mine in Africa ready to start production in Jan. '09 & 2 more mines ready to go in WA as long as the LIBERALS win the vote today in Australia & kick out the LABOR party who opposes uranium mining (Mr. Carpenter).Plus more mines ready to go in Queensland with one of those ventures being partially owned by Areva (10 %).....Finally a 50/50 agreement with Cameco in the Northern territory of Australia on two other mines......HOW CAN PALADIN ENERGY NOT BE MENTIONED IN ANY URANIUM STORY WHEN IT COMES TO LONG TERM PROFITS....ONCE THE URANIUM SECTOR TURNS AROUND;PALAF//PDN.TO WILL RESUME ITS UPWARD TREND !!!

2008 Sep 05 01:45 PM