Uranium Pullback

Noise vs. signal

The uranium sector is experiencing one of its periodic convulsions that make investors question the thesis, and cause panic among speculators and traders who lack fundamental conviction. After uranium price broke above $100 / lb, and the recent KAP and CCJ announcements, a bunch of hot money entered the sector driving many of the uranium stocks up 20%+ within a few days. I also noticed that a number of investing / trading subscription services recommended their subscribers go long uranium stocks, despite having only a superficial understanding of why uranium prices are going up.

It’s not surprising then that, at the slightest sign of trouble, this hot money has come out of the sector as quickly as it came in. Spot prices are taking a breather and pulling back to the mid-90s, after an almost uninterrupted run from $50 to $100+. The pullback in spot shouldn’t come as a big shock given the huge run-up, especially if you’re aware of how the spot market operates towards month-end. Yet, many investors are worried that the rise to triple digits may have marked the end of the bull run. Most notably, I heard through the grapevine that Hedgeye, a prominent institutional research service, sold out of its uranium positions last week.

A lot of the fear and panic is simply the result of not understanding the nature of the uranium fuel cycle, the supply/demand situation, and how we actually got here. A recent Barron’s article erroneously compared uranium to lithium, ignoring the very different supply dynamics in each commodity. Several macro analysts on Twitter have stated that there is some kind of ‘speculative mania’ going on in uranium stocks. Others have compared uranium to ‘meme trades’ like crypto or marijuana. The noise-to-signal ratio in the space is very high at the moment.

Many investors are also using the last uranium cycle as a blueprint for how to trade this cycle - i.e. they are expecting some kind of blow off top. I think such fears are misplaced, and I’ve argued in detail on several occasions (most recently here) why I believe this cycle is fundamentally different.

Let’s tune out the noise and take a closer look at what’s actually happening in the spot market. I had mentioned in a prior article that the spot market is currently suffering from a ‘buyer’s strike’; utilities / fuel buyers are still digesting the sharp move into triple digits, and liquidity has dried up. If you’ve studied the spot market, you know there is a constant drip of supply from price insensitive sellers who produce uranium as a by-product of their mining operations (BHP, Uranium One, Navoi/Uzbekistan etc.), while demand is sporadic / episodic because utilities are typically sitting on a few years of inventory (though those inventory levels have declined substantially in recent years), and make the majority of their purchases under LT contracts with producers. Financial players like SPUT can only buy when they are trading at a premium to NAV. Given the mismatch in timing between uranium spot supply and demand, the market is prone to manipulation by traders.

I’ve confirmed through multiple sources (that are close to the day-to-day trading in uranium spot) that the drop in spot price from $106.50 to $95 was triggered by only a few hundred thousand pounds of trading. In fact, since December, spot market trading volumes have been anemic. There is one trader in particular who, last Friday, in the absence of any bids, aggressively dropped their ask and triggered other traders to do the same. By sharply dropping the ask and causing a mini-crash, the trader looked to make quick profit on their offtake agreement (agreement with a uranium producer to buy pounds at a price linked to the month-end spot price); they are now able to buy at artificially depressed prices and flip these pounds when spot prices recover. It’s important to note that this dynamic plays out at the end of every month, but it’s particularly pronounced during periods of spot market illiquidity.

The above discussion reminds me of a couple of recent quotes from prominent uranium investor, Mike Alkin, who runs the uranium-focused hedge fund Sachem Cove:

"I buy physical uranium in the spot market, so I'm in the spot market. The spot market is made up of about 7 or 8 physical traders who do not have balance sheets that last past a month or so. It's a game of hot potato, and that's all it is. It's mostly traders churning lbs back & forth to each other. "I took in 200k/lbs, let me see if I could flip it to somebody else for a buck or two a lb. That's how they make their living, which is great, but it's not indicative of massive amounts of demand that are needed."

"I can't emphasize enough: market structure & incentives; learn them, and you won't be guided by day-to-day spot prices. It's an upside-down market. It's broken. It's dysfunctional, with infrequent price discovery, which creates unbelievable asymmetry."

Moving our focus towards a more accurate gauge of the underlying fundamentals (term contracting), we see that the bull thesis is progressing as expected: there is currently a massive RFP in the market to purchase 21mm lbs of U3O8 between 2026 - 2040. The implications of this are important to ponder. The RFP is clearly coming from a larger utility that is looking for supply security over a very long duration. This is not the type of RFP a utility would issue in a market where supplies are plentiful. During the bear cycle, LT contracts were shorter (1-3 years), and instead of putting out RFPs, the utilities would sign contracts directly with their favored producer. Future supply uncertainty and limited contracting capacity with large producers is forcing utilities to change their strategy. The large RFP is also likely to trigger smaller utilities to try to secure supplies, as these companies often look to the larger players to make the first move.

In another sign of how uranium has shifted from a buyer’s to a seller’s market, recent LT contracts have been signed with ceilings as high as $120 - $130 / lb. In October, South Korea’s utility KHNP put out an RFP for 6.6mm lbs of U3O8 over 5 years, with a price floor of $58/lb and ceiling of $85/lb. The RFP received no offers and was eventually withdrawn. Per Jander, Director of nuclear fuel service provider WMC (WMC helps acquire pounds for SPUT), stated in an interview last year that he soon expects to see LT contracts with no ceilings.

On the demand side, it seems not a day goes by without a new reactor extension or restart being announced. Most recently, U.S. utility giant Constellation Energy, signaled its intention to operate its Clinton-1 Nuclear Plant until 2047 (slated to shut down in 2027). The government of Canada is exploring a potential doubling of the Bruce Power Plant by adding 4.8GW of new generation capacity, representing Canada's first new large-scale nuclear plant construction in 30 years. The below announcement from the Nuclear Power Corporation of India (NPCIL) also caught my attention given its size / scope. India seems to be following the same path as China, steadily increasing its nuclear footprint to end its reliance on coal.

I won’t repeat the global uranium supply / demand math here as I have discussed that in detail several times in the past. But in moments when volatility is elevated, and you’re being bombarded with noise, it’s important to step back and refocus on the big picture:

• Uranium remains in a large structural deficit which is slowly being crystallized through replacement rate / above replacement rate contracting.

• Demand is steadily increasing, as global leaders realize there is no possibility of a green future without rapid expansion in nuclear capacity.

• Supply growth remains uncertain, with even the largest, lowest-cost producers struggling to increase production in any meaningful way, and the largest developers still several years (3-5+) away from production.

  • A near-term spike in prices will not make new mines come online any sooner, as uranium is one of the hardest commodities to produce with complex supply chain and regulatory hurdles.

• Geopolitical bifurcation is making the situation even trickier for Western utilities, who can no longer rely on supplies coming from Kazakhstan.

• Despite the recent rally in spot price and the equities, the valuation of the sector remains miniscule in comparison to its economic and strategic importance.

P.S. If you would like to learn more about the psychology and market dynamics behind corrections, and how to take advantage of them, refer to my note on momentum.