Lithium stocks are having a tough 2018, following two years of partying like it was 1999. Shares of the world's largest lithium producer, Albemarle (NYSE:ALB), are in the red 25.7% this year through Friday, while the stocks of the industry's second-largest producer, Sociedad Quimica y Minera de Chile (NYSE:SQM), or SQM, and the other big player that's traded on a major U.S. stock exchange, FMC Corp. (NYSE:FMC), are down 19.4% and 15.9%, respectively. For context, the S&P 500 has returned 1% over this period.

Here's what you should know.

Lithium salt flats -- showing lithium-containing brine in evaporation ponds, with mountains and blue sky in background.

Lithium salt flats. Lithium-containing brine is pumped above ground into evaporation pools. Image source: Getty Images.

Lithium oversupply and pricing concerns hit the group beginning in January

Albemarle, SQM, and FMC ended 2017 on a high note, with their stocks returning 50.2%, 114%, and 68.8%, respectively, for the year, versus the S&P 500's 20.5% return. This was on top of big gains the year before. The two-year stock party was driven by the companies' lithium segments posting strong revenue growth and even stronger profit growth, thanks to increasing demand for the silvery white mineral to make lithium-ion batteries for electric vehicles (EVs). Supply has been having a tough time keeping up with the robust demand, resulting in prices for lithium carbonate than doubling in two years. So the companies have been benefiting from selling higher volumes of their lithium products as well as getting higher prices for them. 

In mid-January, however, concerns surfaced that the price of lithium could be under pressure. The impetus was news that SQM had resolved its dispute, centering on its royalty payments at the Salar de Atacama, with Chile's economic development agency, Corfo, and received the green light to hike its annual lithium production quota. Shares of lithium stocks got hit when news came out because the big quota increase means that SQM will likely be producing more lithium than Wall Street analysts had been using in their price projections. 

In late February, the market sent lithium stocks tumbling once again, as the chart below shows. The culprit was a particularly bearish forecast by Morgan Stanley that the price of lithium carbonate would decline 45% from current levels to $7,332 per metric ton in 2020 because of a projected surplus in the lithium market of 190,000 metric tons by that date. The Wall Street firm said that new lithium projects and planned expansions by the big producers in Chile -- which are SQM and Albemarle -- will add about 500,000 metric tons of lithium carbonate to the market by 2025, the Financial Times reported. Morgan Stanley predicts there will be "significant surpluses" in the lithium market beginning in 2019, and said that electric cars would have to comprise at least 31% of total global auto sales in 2025, from the current 2%, to avoid a lithium glut at that time, the Times also reported. Moreover, the firm also downgraded its ratings on the stocks of Albemarle and SQM to underweight from equal weight.

SQM Total Return Price Chart

Data by YCharts.

What's an investor to do?

The first thing investors should do is run from anyone who professes to know with a good amount of certainty how the lithium pricing situation will pan out more than a year or two down the road. The second thing to do is put the price drops of the lithium stocks in perspective. Yes, year-to-date declines ranging from FMC Corp.'s 16% to Albemarle's 26% are big reductions in just two months. But these are minor pullbacks relative to the stocks' soaring returns since 2016. Despite the 2018 pullbacks, since 2016, SQM, FMC, and Albemarle have returned 175%, 108%, and 74.3%, respectively, through Friday, versus the S&P 500's 37.8% return. 

Time could prove me wrong, but I believe that investors who hold select lithium stocks for the long term will be rewarded, even though there may be further pullbacks over the short and intermediate terms. Why do I believe this? For one, I think that some Wall Street firms are underestimating future lithium demand by underestimating how fast consumers will adopt electric cars. Moreover, judging by the ordering frenzy generated from Tesla's unveiling of its electric truck late last year, it appears that electric trucks could also displace their internal-combustion engine brethren faster than many seem to believe. Second, it seems more likely than not that Morgan Stanley's supply projection will prove too rosy. The lithium industry has historically overestimated how fast it can bring new supply on line and there's no reason to believe things have changed on this front.  

You don't need to take just my opinion that Morgan Stanley's lithium analysis appears to have some sizable holes. Select industry experts are saying the same thing. Analyst Andrew Miller at Benchmark Mineral Intelligence, a U.K.-based battery metals consultancy, told Reuters: "Forecasts of oversupply also fail to take into account that few lithium processors have the capacity and ability to produce the very high-grade lithium compounds that batteries need." Joe Lowry, who runs a lithium advisory firm and is widely considered one of the world's top lithium experts, weighed in to the Financial Times: "The "analysts" at Morgan Stanley predicting a steep lithium price decline prove they don't understand supply, demand or the cost curve."

Beth McKenna has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.