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The Energy Report

The Energy Report

Investors rely on The Energy Report to share promising investment ideas in the energy industry with institutional and high-net-worth retail investors. Its exclusive interviews with…

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Benefit from the Coming Equity Uptick in Uranium, Potash, and Coal

For Jeb Handwerger of Gold Stock Trades, it's not a matter of if the uranium sector will rebound, but when. He's already pounced on the three-year low that hit the spot price in 2011, but as Handwerger tells The Energy Report, investors can still benefit from an equity uptick in the uranium, potash and coal sectors.

The Energy Report: In your view Jeb, what factors are influencing energy markets right now?

Jeb Handwerger: The junior market and the Toronto Stock Exchange Venture had a considerable downtrend since the beginning of 2011. A downtrend like this creates a fear that this will never end, and this ultimately becomes the consensus among investors. But one has to really think rationally during these periods of extreme pessimism. When there's fear and blood in the streets is when the investors who have a longer-term approach are able to buy cheap assets. Declining prices have been occurring against an improving fundamental background. Investors have to overcome the fear and panic and look at the improving underlying technicals we're seeing in many of the markets, especially in energy, and particularly in nuclear.

TER: Do you see any catalytic event, or is this just going to be a slow transition?

JH: We're already seeing the catalytic event. Last October, uranium hit $40/pound ($40/lb) and investors completely neglected the sector. I said "pounce on three-year lows" and argued that increased mergers and acquisitions (M&A) would be a major catalyst. Since then, there's been a major M&A uptick in the uranium sector. ARMZ Uranium Holding Co. took Uranium One Inc. (UUU:TSX) for a premium right after that. Then Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT) made the takeover deal for Fission Energy Corp. (FIS:TSX.V; FSSIF:OTCQX) and Fission announced a spinout. The spinout is hitting high-grade stuff at the Patterson Lake South, and JV partner Alpha Minerals Inc. (AMW:TSX.V) has soared sevenfold.

There are so few public, producing uranium companies out there. As more are picked off, there will be even fewer companies in the space, which will cause a price spike in equities. That buying will create more buying as the market reaches extreme euphoria. We saw this in 2010, before Fukushima, when these stocks could move about 300–400% in weeks. That's how fast these things could turn.

There are also plenty of mine delays. Majors like Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) and BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) are having to defer projects that account for over 20 million pounds (20 Mlb) of potential supply. There are long-term delivery deals being made, such as the one Paladin signed with utilities. Japan is restarting many of its reactors and investing in new technology to update the plants that are offline. The real demand for uranium is generated by China, which is building many new reactors. The U.S. gets 20% of its power from nuclear; China currently gets only 2%. China is dealing with really serious air pollution issues from coal-fired power plants, and is pushing to switch to nuclear power.

The demand fundamentals are extremely strong, yet the price of uranium hasn't reacted. Gold nearly doubled since pre-2007 highs at $1,000 and is still up 60%. Uranium had a high of around $137/lb and is now 70% below that. Uranium has a lot of catching up to do, considering the potential supply shortfall in 2014, when 14% of the world's supply, which the U.S. relies on, is coming off the market. People don't realize the U.S. uses 50–60 Mlb of uranium each year. It's the largest uranium consumer, yet only 4 Mlb come from domestic production. It imports all of this from secondary suppliers. That's why the U.S. junior near-term producers are going to be the next targets. The Athabasca Basin explorers are going to get a lot more investment interest. Europe has 160 nuclear reactors, the largest per capita in the world. It only has one operating uranium mine, in the Czech Republic. So Europe is going to have to look for additional supplies domestically. These are the areas that investors need to focus on.

TER: What do you think is going to happen with the dozens, if not hundreds, of smaller uranium explorers floating around out there, which may or may not be able to survive?

Related article: Developing Countries Expected to Drive a Nuclear Power Boom

JH: Many companies, especially the juniors, will have to band together to protect their assets, especially if they have cash. There's going to be a lot of consolidation among the juniors. The near-term producers are going to be targets. This disconnect is creating an opportunity for private equity to come in and pick up these assets for pennies on the dollar. So management is going to have to really think of ways to do strategic mergers and acquisitions in order to protect shareholders.

TER: Let's talk about some of the companies you like.

JH: Among the near-term producers in the U.S., you have Uranium Energy Corp. (UEC:NYSE.MKT), which is in Texas and producing. You also have Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT). Our favorite takeout target, though, is Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.MKT), which is in construction at its Nichols Ranch project in the Powder River Basin. Nichols Ranch is surrounded by Cameco and Uranium One. The Powder River Basin has been producing uranium for decades. Uranerz already has a processing agreement signed with Cameco. We think that Uranerz should be top of the list for near-term U.S. producers.

I like European Uranium Resources Ltd. (EUU:TSX.V; TGP:FSE; EUUNF:OTCQX), which is located in Slovakia, where a large part of its power comes from nuclear. It signed a memorandum of understanding with the Slovakian government, which is very pro-nuclear and building two reactors. This could provide uranium for European utilities. European Uranium is now at the feasibility study stage and AREVA SA (AREVA:EPA) is a major shareholder.

South America is a region that is not really thought of for uranium, but U3O8 Corp. (UWE:TSX; UWEFF:OTCQX) just came out with a positive PEA on its Berlin project in Colombia. Because the deposit has rare earth elements (REEs) like phosphate and vanadium as a byproduct, U3O8 could produce the uranium at zero cost. The company also is going into Argentina, which has a nuclear program. U3O8 is becoming the major Argentinean uranium developer.

In Canada, we like the Elliot Lake region, which has a history of uranium production with REE byproducts. One of the companies we're following up there is called Pele Mountain Resources Inc. (GEM:TSX.V).

In the Athabasca Basin, we're of course following the Fission discovery at Patterson Lake South. We're also following Athabasca Uranium Inc. (UAX:TSX.V; ATURF:OTCQX), which has the seismic team from the University of Saskatchewan, where Dr. Zoltan Hajnal, a very experienced seismologist, was very instrumental in the Hathor Exploration Ltd. discovery. Athabasca Uranium has some really great properties and interesting targets.

Another one that we're following is a company called Lakeland Resources Inc. (LK:TSX.V). It has some interesting properties. We know the management team from Zimtu Capital Corp. (ZC:TSX.V) and we're excited about some of the properties that have come into that.

TER: Are a lot of these companies undervalued?

JH: Yes. The recent uranium acquisitions, like Fission and Uranium One, were valued about $10/lb. Uranium One was acquired for $12/lb. Hathor was about $10. Compare those to what enterprise value per pound some of these juniors are trading at. European Uranium is $0.42/lb and U3O8 is $0.72/lb. They're just ridiculously undervalued. Just taking that as a comparison, you see what sort of discount you can get now in the market. If this M&A continues in H2/13, and we believe it will, you're going to see a major rerating. That's why these companies are going to have to band together. With fewer companies, there would be a focus for investment capital and for the public markets instead of having it spread around. Real properties in places like the Athabasca Basin or Elliot Lake will not just disappear. Either they're going to go into private hands or be merged. This is what happens in this sector.

TER: What other resource sectors are you following?

JH: Potash is one area we all understand because we need fertilizer to feed growing populations. Potash is controlled by a few companies but the real demand over the next decade is going to come from China and India. India has no domestic potash. China is now the largest consumer of potash. The U.S. imports 90% of its potash. One company we've recently become aware of is Passport Potash Inc. (PPI:TSX.V; PPRTF:OTCQX), which just came out with a preliminary economic assessment (PEA) on its potash project in the Holbrook Basin. Passport is very impressive because it has one of the lowest-cost potash projects under development.

Related article: Iran Announces Discovery of Huge Uranium Deposits

TER: Where is the property?

JH: It's in Arizona, which is an extremely mining-friendly jurisdiction. Passport is working now on completing its prefeasibility study by the end of 2013 and the feasibility study by the end of 2014. It is working with strategic partners that could help fund further development. With China and India's economies beginning to rebound, these potash plays are going to attract a lot of interest. Passport's PEA is showing real numbers, and the stock is still undervalued. It's a very exciting project and the stock could experience a rerating as more people become aware of it. Passport has a very strong management team. Its chairman was with Rio Tinto for 17 years.

TER: Any other companies catching your eye?

JH: We're looking at the undervalued and beaten-down coal sector, which was hurt by a powerful natural gas lobby that claims natural gas is a cheaper and safer alternative. We like CanAm Coal Corp. (COE:TSX.V) because of the increasing regulations aimed at reducing sulfur, arsenic and mercury pollution. CanAm has a higher-quality coal that is going to get premium pricing. Unlike many juniors, CanAm has cash flow and earnings before interest, tax, depreciation and amortization deductions (EBITDA) growth with long-term contracts with Alabama utilities and industries.

CanAm's fundamental production growth since 2010 is remarkable and it has made strategic acquisitions. The global coal market looks promising in the medium term, especially because of Asian demand. The U.S. market is challenging due to low gas prices, but the higher-quality projects and lower-cost producers will continue to do well. The 2013 outlook looks very good for the company, with production revenue and positive cash flow. It already has long-term contracts for 2014 and 2015. It has some very good operators that have been in the industry for 30 years. Its properties are in Birmingham, Alabama. It has four operating mines there. CanAm is a real value play with a market cap below $20 million. Coal is another area that's coming out of a two-year downturn and may create a lot of value.

TER: So what's your investment strategy now?

JH: You have to buy when there's blood in the streets and real value. That's when you have to step in and pick up the bargains. One should fight the crowd when you see value and learn to wait. To paraphrase Jesse Livermore, money is not made in the buying or selling, but in the waiting.

Many investors are chasing the latest trend hitting new highs rather than doing their homework and finding discounted opportunities that are trading close to liquidation levels. Look at discounted opportunities, study the fundamentals and invest in bargains. Stay away from chasing sectors that are overbought with questionable fundamentals. Be careful of analysts who recommend stocks at 50 times earnings and ignore companies that are trading below book value or cash value.

TER: It was good talking with you, Jeb.

JH: Thank you so much.

Jeb Handwerger is a newsletter writer who is syndicated internationally and known throughout the financial industry for his accurate and timely analysis of the equities markets—particularly the precious metals sector.

By. Zig Lambo of the Energy Report




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