by Scott Baker –
Many investors follow the ups and downs of oil prices, gold prices, even steel prices, but chances are there’s one key industrial commodity you never think about. I’m referring to uranium. You rarely hear its price quoted, and other than the occasional article about the problems of getting rid of the stuff after it’s been used, no one pays much attention to it.
This quiet period may be about to end. After years of stagnation, the uranium market is displaying signs that it may have entered a long period of rising prices. If you’re looking for a risky but potentially very profitable investment, you should pay attention.
This is not an investment for the faint of heart. The uranium industry operates a bit like a private club. A handful of private and state-owned producers dominate the business and the total market capitalization of all the publicly listed producers stands at less than $30 billion. These producers sell to a small group of reactor operators. Since the numbers of both buyers and sellers are so limited, information about inventory levels and other industry fundamentals is scarce.
The information that is public shows a booming industry. From 1979 to 2000, prices for uranium drifted lower and producers did little exploration. But since 2000, when the spot price hit $7 (U.S.) a pound, the market has turned around in spectacular fashion. Spot prices have soared to around $29 (U.S.), while longer-term contracts fetch prices approaching $30 (U.S.) a pound. The world is consuming 170 million pounds a year of uranium and, by some estimates, demand is running ahead of supply by 20 million to 30 million pounds annually. The shortfall is being met by drawing down inventories and reprocessing nuclear weapons in Russia, but both sources are thought to be in decline.
How high could the price of uranium go? Current prices are still well below the nearly $50 (U.S.) level reached in the late 1970s. Mining companies are rushing to find new deposits, but help will be a long time coming, because it takes years to find and develop a uranium mine. Meanwhile, demand for the radioactive element is growing by about 2% annually; China alone has about 40 nuclear plants on the drawing board.
With most industrial materials, higher prices would reduce demand. But uranium is a special case. There is no substitute for it in fueling nuclear reactors, yet its cost makes up only about 2% of the cost of building and running reactors. As a result, higher prices are not likely to deter consumption. The price of uranium will continue to rise until enough supply comes on stream to meet demand. Since mines take so long to develop, uranium prices are likely to keep moving higher— perhaps substantially higher — over the next several years.
How do you capitalize on that trend? The safest way is to invest in Cameco, the Saskatoon-based company that is the largest publicly traded uranium producer in the world. Its share price has soared over the past year and, at $48 at the time of writing, it’s no longer the great deal it once was. Still, it’s well worth buying, especially if its price dips. Using conservative long-term prices of $20 (U.S.) per pound for uranium, and discounting the cash flows back to the present at 10%, I estimate Cameco’s net asset value (NAV) to be about $43 per share. Each dollar increase in the long-term price of uranium adds another buck per share to the NAV of Cameco, so fair value for the stock, assuming higher uranium prices, is likely to lie somewhere between $43 and $53. Given the likelihood that Cameco will trade at a premium to NAV in the same way that large gold companies do, the company could be worth as much as $60 a share.
Smaller exploration companies such as Strathmore Minerals or Aflease Gold and Uranium are far riskier and will need long-term prices to hit $30 (U.S.) to justify mining their reserves. However, if those prices hold, the upside is tremendous. These companies could climb to three to four times their current values.
Investing in uranium involves risk, but the world needs reliable and clean energy sources, and the nuclear industry is poised to enter a new era of growth. Uranium producers and explorers should be well rewarded along the way, and smart investors will keep a close eye out for buying opportunities.