Miners Face Uncertain Future as Uranium Deleveraging Continues

It’s been a long time coming. I don’t know who thought it would come this fast…or all at once.

A few weeks ago, uranium prices seemed to have a gained some footing. But uranium prices crashed through the floor and it could be another big step down from here. The energy metal could be headed even lower. This fall could be harder and faster all due to deleveraging.

The nuclear energy argument is still there. In fact, it’s even better than it was two years ago when the uranium market started to crack.

At the time there were plans for the construction of 222 new reactors. Today there are plans for 316 and 60 of them are expected to be on line by 2014. Although I think the world is starting to realize a lot of those will replace old reactors, but not all of them.

Also, the recent update on Cameco’s (CCJ) Cigar Lake project wasn’t very good news either. As most of us expected, it’s a long way from recovering from the flood. The doubts still loom if it will ever be fixed.

We also learned a bit more about the Megatons to Megawatts uranium deal with Russia. As it sits right now, Russia will be halting shipments of uranium in 2013.

As you can see, the uranium story has actually improved a good bit. But that doesn’t matter much now. There is a much larger storm cloud hanging over the uranium spot market and uranium stocks: hedge funds.

By now most of us are familiar with deleveraging. After years of success and taking big bets, hundreds of hedge funds are on the verge of collapse. The markets have taken a turn for the worse and investors are calling for their money back. Hedge funds have to pay up. Record redemption rates are forcing them to sell anything off at any price.

For many funds that trade actively in large-cap stocks, raising cash for redemptions is not much of an issue. It’s a much different story for the funds that were buying physical uranium a few years ago. If they have to sell, they’ll have to do so at any price. Any added selling pressure in a weak and illiquid uranium market could have a big impact on uranium prices. It looks like it’s already started to happen.

In the past few weeks uranium prices have fallen another 14%. Each week the price of uranium drops another few dollars per pound indicating a very weak market. It’s not just a one-time drop either. The fall has been consistent. That means the funds could be unwinding. If they are, there’s a lot more down weeks to come for uranium prices.

It wasn’t long ago that everyone was buying uranium. The stocks were the hottest thing around and funds were consistently buying up anything uranium.

During the uranium heyday, a uranium trader stated, “They sweep the market clean. Every pound they can find.”

The Wall Street Journal said back in 2006, “Many funds say they are holding their uranium off the market because they expect the price to climb.”

It was all artificial demand for uranium. It was unsustainable. They were just buying it with the only possible exit strategy of selling it. They had no use for it. There’s nothing wrong with that…as long as they stay aware of it.

And now it looks like we’ll be forced to become all too well aware of it. All the uranium the funds swept up has to go back onto the market. And that could push uranium prices to ridiculously low levels we haven’t seen in years. It wouldn’t surprise me to see uranium back at $40…or lower. It all depends on how fast they have to sell.

For instance, Adit Capital was one of the biggest buyers of uranium between 2004 and 2006. It’s estimated that Adit purchased between four and five million pounds of uranium. Citadel Investment Group controlled 2.3 million pounds of uranium.

The big wild cards here are GLG Partners and Fortress Investment Group. These multi-billion funds could be sitting on millions of pounds of uranium they may want or need to liquidate quickly.

In addition to all that, we can’t discount the impact of the artificial demand created by Uranium Participation Corp. As of September, Uranium Participation Corp was holding 5.425 million pounds of uranium and more than two million pounds of uranium hexafluoride.

Although Uranium Participation Corp is a holding company that probably won’t be liquidated any time soon and they have created a uranium loan program, the demand the fund created on uranium’s way up will not be there on the way down. In August, the fund only purchased 50,000 pounds of uranium. That’s nothing close to the 200,000 pounds a month it was bidding up when uranium prices were rising week after week.

Although we cannot determine exactly how much uranium these funds have left, we do know they throw another variable into the uranium mix. In a market like this, where even slight uncertainty can send share prices plummeting 10% to 20% in a single day, another variable is the last thing the market wants to see.

As a result, I recommend holding off on uranium stocks for the time being or wade in and use a prudent investing strategy that reduces risk. The trend is still down. We might have caught a nice run with Hathor Exploration and Denison Mines (DNN), but uranium prices have broken through the temporary floor. The wide sell-off hitting almost all commodity stocks could get even worse and now the best place to be is on the sidelines.

Uranium prices could fall another 50% or more from here if these funds liquidate. There could be another 5 to 10 million pounds of uranium just waiting to go on the selling block. Considering the spot market is very illiquid (it only trades 26 million pounds a year), uranium prices could have plenty more room to slide. The consequences on uranium stocks would be even worse.

Do you remember what happened to natural gas stocks when the hedge fund Amaranth had to unwind its bet on natural gas in 2006? The fund single-handedly pushed natural gas prices from $7 per Mcf to almost $4 per Mcf. The same fate could be headed for the uranium market. If that happens, then uranium would be an easy buy.

For right now, I’m afraid; the risks just outweigh the rewards in uranium stocks. There could be a true fire sale for uranium stocks coming up. To me, the opportunity to pick up high quality uranium plays like Hathor and Denison around $1 per share or Cameco under $10 (it could happen) is something worth waiting for.

Disclosure: I have no position in any of the companies mentioned.

Comments

[Bill Herbert:]

Andrew,

You are one sick puppy.

CCJ under $10 is ludicrous (although I note it actually sank to as low as $12 intra-day) when Uranium demand should be steady, and growing, for the next 50 years, at least!

This market dislocation is mindboggling in how the prices of companies with great resource bases are being trashed mercilessly - just because a bunch of idiots at hedge funds are leveraged 10-to-1 and then make reckless trades, like writing $100MM worth of CDS on banks, that they can't possibly cover.

We need to shut down 90% of the hedge funds ASAP if it results in this sort of market madness.

Sick, Sick, Sick!!!

2008 Oct 10 07:25 PM