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Discovery In Graphite Is Alive And Well

Movement Amidst The Carnage - Discovery in the Graphite Space is Alive and Well

Despite the uncertain economic climate and the fall in graphite share prices (see chart), our graphite index continues to grow in size. We are now tracking 44 companies who are collectively managing over 90 graphite projects.

Source: Bloomberg

Here is a listing of the year-to-date price performance of each of the companies which comprise the index as of May 29, 2012.

Company

YTD % Change

SYR

1317.65%

TLG

185.71%

ZEN

158.62%

LMR

142.86%

FGR

109.09%

NGC

104.35%

CVN

100.00%

GPH

90.48%

LML

68.54%

SRK

68.18%

AXE

66.67%

GR

50.00%

EGZ

31.58%

BRU

30.43%

GXY

27.78%

MOX

25.00%

OLA

22.22%

VLC

20.83%

RBW

15.15%

SGH

10.00%

SOV

8.33%

PNS

6.25%

FMS

5.41%

CNG

0.00%

LC

0.00%

TFR

-6.67%

NRT

-15.00%

BVQ

-16.67%

LRA

-17.36%

ASW

-18.18%

CIN

-18.18%

UBR

-20.00%

ATT

-20.00%

KEX

-25.00%

RA

-25.00%

AEL

-27.27%

FDR

-30.17%

CKR

-42.31%

GMA

-46.60%

BSM

-55.56%

UNR

-58.33%

SER

-61.25%

AWH

-78.26%

CJC

-80.36%

Source: Bloomberg; Ed Note: Prices between Jan 3, 2012 (or earliest available in 2012) and May 29, 2012

Graphite has many current-day and future applications (one of the reasons we like the future prospects and application for the material). However we believe you can get a sense for current and immediate future graphite demand by looking at macro-economic indicators such as Purchasing Managers Indices (PMIs). If graphite is to be considered an industrial mineral and PMIs are reasonable gauges of industrial demand, the picture isn't terribly promising in the near-term. As an example, the HSBC China Flash PMI (an estimate of the official PMI data) registered at a 48.7 in May which indicated the seventh straight month of economic contraction in China. Similar falling data points are to be found in other parts of the world including Asian countries and the Eurozone. Generally, a score below 50 denotes economic contraction. In addition, reports of prices for high purity flake graphite have declined by more than 10%. Consequently, you are left with a rather uninspiring demand picture.

Signs of Life

Still, despite all the gloom in the markets, there are signs of life in the graphite space. First, Graphit Kropfmuhl AG, one of the largest producers of silicon metal and high purity natural graphite in the world just announced plans to bring its Kropfmuhl graphite mine located in Germany into production with the intent of producing 5,000 tpy of high purity natural graphite. This is significant, but what really stood out to us was that the company indicated that the graphite produced will be for domestic consumption. The company currently sources raw materials from other graphite deposits in Asia and Africa in which the company has an ownership stake.

We have discussed, time and again, the criticality of security of supply to ensure a smooth, economic and functional supply chain. Clearly this was not lost on Graphit Kropfmuhl management. The company sees a solid future for high purity graphite demand - something we should all remember as our graphite shares bear the brunt of near-term global economic uncertainty. Economic activity (aka growth) will return, and when it does, those companies with sound business models, sustainability, and supply chains will be positioned to create shareholder wealth.

The Two C's: Catalysts and Costs

There are also several potential share price catalysts in the graphite junior space we are watching. Northern Graphite (NGC: TSX, NGPHF: OTCBB) plans to release the results of its bankable feasibility study on the Bissett Creek project in the near future. NGC has always been and remains our favorite in the graphite space for its management capability and experience and potentially strong project economics.

Focus Metals (FMS: TSXV, FCSMF: OTCQX) has plans to release the results of its preliminary economic assessment on its Lac Knife deposit shortly as well. As these two companies were among the first to capitalize on the interest in graphite, they are looked to as proxies in the graphite space when evaluating advanced projects. Flinders Resources is also a recent addition to this group of "leaders". It's true that the companies have differences; but the investing public and junior graphite executives look to them to gauge how a company can mature from explorer (Incubator discovery company) to developer (Mature discovery company) to (potential) producer.

In each case, we're most interested to look at the potential costs associated with each project. It's no secret that costs for all mining companies - from exploration to those in production - have increased in recent months. These increases can take the form of higher taxes or cost inflation in working capital and capital expenditures. This is why we think sustainability - the ability to minimize costs in a time where financings are hard to complete - is likely the most important Discovery factor when evaluating a junior resource company.

Discovery Continues in Graphite

Risks aside, discovery is still alive and well in the graphite space. One such example concerns Syrah Resources (SYR:ASX), an Aussie-listed graphite explorer with properties in Tanzania and Mozambique. We first learned of this company at the PDAC Convention in March after meeting with company officials. We have been tracking SYR's progress. The company recently reported that their first drill hole intersected 287.5 meters of (apparently high grade) graphite mineralization from surface and the hole ended in mineralization. There are those among us who would categorize this result as a potential "company maker". We'll defer that decision to assay and additional drill results, but it is impressive and demonstrates what happens vis-à-vis shareholder wealth creation when a "discovery" is made. The chart below shows the one year price performance of SYR.

Source: Bloomberg

Other notable examples of discovery in graphite include Energizer Resources (EGZ: TSXV, ENZR: OTCBB) which drilled 106 meters of 8.44% C on their Molo deposit in Madagascar, and Zenyatta Ventures (ZEN:TSXV) which reported a 450 meter step out hole which included 170 meters of 6.6% C on its Albany graphite project in Ontario.

This isn't a Bubble - Not Yet

While we have heard talk about graphite being a bubble, we disagree - for now. There clearly won't be room for the many junior resource companies entering the graphite space today, but with the failure rate so high in junior mining and the looming need for additional reliable and cost-effective graphite supply for next-generation applications such as lithium-ion batteries, we welcome all comers. That said, it behooves investors to pick companies in this space carefully, paying particular attention to cost sensitivities and the composition, or "footprint", of a given deposit as this can substantially improve economics.

The material herein is for informational purposes only and is not intended to and does not constitute the rendering of investment advice or the solicitation of an offer to buy securities. The foregoing discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (The Act). In particular when used in the preceding discussion the words "plan," confident that, believe, scheduled, expect, or intend to, and similar conditional expressions are intended to identify forward-looking statements subject to the safe harbor created by the ACT. Such statements are subject to certain risks and uncertainties and actual results could differ materially from those expressed in any of the forward looking statements. Such risks and uncertainties include, but are not limited to future events and financial performance of the company which are inherently uncertain and actual events and / or results may differ materially. We own shares in Northern Graphite, Strike Graphite, Standard Graphite and First Graphite . In addition we may review investments that are not registered in the U.S. We cannot attest to nor certify the correctness of any information in this note. Please consult your financial advisor and perform your own due diligence before considering any companies mentioned in this informational bulletin

Disclosure: I am long OTCQX:NGPHF.

Additional disclosure: Also long Strike Graphite (OTCPK:SRKZF), Standard Graphite (SGH.V), and First Graphite (OTC:IAXFF) (tickers not available in dropdown).