Why I'm Bullish on Uranium

I'll come right out with it: "Buy low, sell high" is a myth.

Or, rather, it's an ideal. In my experience, investors get most excited when the market is hot, and they get most depressed when the market is near a bottom. (Psychological studies back that up.) So, they do just the opposite: Buy high and sell low.

That's what happened with uranium two years ago. But if you're willing to do your homework, you'll find that uranium looks like a good long-term opportunity now.

The spike
In 2007, it seemed that everyone was bullish on uranium -- so much so that the market exhibited classic bubble characteristics. The uranium market traded as high as almost $140 per pound for "yellowcake" -- the nickname for the U3O8 form of uranium oxide that trades on the wholesale level.

According to statistics from uranium producer Cameco (NYSE: CCJ  ) , most uranium is sold through long-term contracts -- about 85% of total annual production. Only the remaining 15% trades on the spot market, where the biggest price moves were concentrated. Back in 2007, spot prices diverged substantially from the prices under long-term contracts.

As the only significant non-military users of uranium, nuclear power plants are its natural consumers. But when speculators enter a small, highly illiquid, and specialized market designed for electric utilities, you can see the explosive move that caused spot prices to jump tenfold in just four years.

And there's evidence that speculators did play a role. For instance, according to Bloomberg, bankrupt Lehman Brothers may hold as much as 500,000 pounds of yellowcake, enough to make a nuclear bomb.

Lehman's uranium holdings -- worth about $25 million at current spot prices around $50 per pound -- have been an overhang on the market. But recent statements from China and India indicating that they plan to continue with their nuclear reactor construction plans regardless of the economic slowdown have played a role in stabilizing the spot market.

Market disequilibrium
Cameco notes that since 1985, uranium use has exceeded available supply from Western sources. If demand for nuclear power continues, this 24-year shortfall in production could one day play a number on the uranium price; it is not unreasonable to expect to see uranium surpass that $140 highwater mark established in 2007.

Production from mining currently satisfies only 62% of market demand. The remainder comes from reprocessing of used reactor fuel, stockpiles, and the dismantling of nuclear weapons. The dismantling process -- coming mainly from Russia -- is due to end in 2013, which will result in the equivalent of a large mine being completely shut down. And with 96 new reactors due to be completed in the next 10 years, uranium demand is rising even as supply is shrinking. That's a recipe for rising prices.

Producers
Uranium is a very small market compared to crude oil -- which is why it is dominated by a few big players, many of which are not publicly traded or are majority-controlled by their respective governments.

Yes, there are a lot of small miners that claim to have struck "a gold mine," but many of those are too unproven for serious investors -- Uranium Resources, Uranium Energy, and Denison Mines (AMEX: DNN  ) among them.

Major Uranium Producers

2007 Production (millions lbs U3O8)

Cameco

20

Rio Tinto (NYSE: RTP  )

19

Areva

16

Kazatomprom

12

Russia

10

BHP Billiton (NYSE: BHP  )

9

Navoi

6

Uranium One

2

General Atomics

2

Other

13

Source: Cameco.

As the world's largest uranium producer, Cameco itself owns stakes in several small miners. That's a tempting proposition, since if they're good enough for Cameco to invest in, they might be good enough for you. But non-producing companies with claims on expensive-to-develop deposits at a time when credit is hard to obtain carry their own risks, which is why I'm not advocating them here.

The big one
When it comes to a concentrated uranium play, Cameco is it. It is more dominant in the sector than ExxonMobil (NYSE: XOM  ) is in oil. The company claims to deliver 15% of world mine production and has about 500 million pounds of proven and probable uranium reserves.

The company has begun to diversify its operations by expanding its geography and using a variety of mining methods. A big area of expansion is Kazakhstan, where production is expected to begin this year. As the European Nuclear Society notes, Kazakhstan has more cost-effectively accessible uranium resources than Canada -- 378,100 tons vs. 329,200 tons -- but is producing much less at the moment.

I have written about Rio Tinto's funding troubles before, but given that they are close to resolution, and that it produces almost as much uranium as Cameco, Rio is a good company to consider. Yes, it is much more diversified, so uranium is not as big of a deal to this mining conglomerate. But uranium is still a bigger deal for Rio than it is for BHP Billiton. Plus, Rio Tinto is still much cheaper than BHP on price-to-book or price-to-sales bases.

I believe that the problem of inadequate supplies of fossil fuels on the horizon will become evident after this recession runs its course. Even now, energy prices are back on the rise, and companies like Chevron (NYSE: CVX  ) and Chesapeake Energy (NYSE: CHK  ) have seen their stocks start to recover somewhat. Uranium is another way to tackle the looming energy crisis -- and uranium stocks, even after a fair-sized bounce from recent lows, still look good to me.

More on uranium:

Fool contributor Ivan Martchev does not own shares in any of the companies in this story. Chesapeake Energy is a Motley Fool Inside Value pick. The Fool owns shares and has written covered calls on Cameco. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


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  • Report this Comment On July 26, 2010, at 4:24 PM, ragedmaximus wrote:

    IF your bored with the continuous rise in the stock market until the inevitable crash, try typing any word into the fool search engine and you can go back in time and read what the fool folly had to say and how much salt it's worth.looks like this uranim pick went up 30% and now flatline....................

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