Sidestepping the Uranium Bubble

On August 17, the Sprott Physical Uranium Trust (TSX:U.UN, OTC:SRUUF, nicknamed SPUT) put out a press release announcing a US$300 million at-the-market (ATM) offering of common shares, the proceeds intended for purchasing uranium in the spot market.

The #uraniumsqueeze was on. This wasn’t the first shot at it by any means. Junior uranium companies had tried buying inventory in the spot market earlier in the year in order to get the spot price up, but with little success. SPUT, however, would succeed spectacularly.

Chart sourced from numerco

Hedge funds saw the bubble forming and attempted to blow it bigger. It helped that Sprott has a huge retail following as well. The more the merrier.

It didn’t matter that by advertising its intent so blatantly, SPUT was merely raising prices on itself by discouraging sellers from accepting the current bid. After all, why sell at $30.5/pound, the prevailing spot price on 8/17, when there was an indiscriminate buyer ready to hoover up inventory. While a normal buyer would attempt to buy as much as possible as cheap as possible, to all appearances, SPUT had the opposite intention – to pick up as many pounds as possible in as little time as possible and damn the price.

In the Livermore days, they used to call this painting the tape.

In SPUT’s case, raising the spot price would make its inventory more valuable, which increases NAV, which in turn increases the share price and lowers dilution from its ATM offering. The fund created a positive feedback loop which enabled it to really shake the spot market.

Now for some context.

Unlike other commodities, where spot price literally means the price for immediate delivery, with uranium, the spot market merely calls for purchases to be delivered within a year. There is no real spot market – the spot price is imputed by various firms like TradeTech, UxC, numerco, etc. based on the actual transaction history.

And it’s a pretty thin market.

“The volume reported by UxC for 2020 was approximately 92.2 million pounds U3O8 equivalent, compared to 64.3 million pounds U3O8 equivalent in 2019. The 2020 total surpassed the previous annual record of 88.7 million pounds U3O8 equivalent in 2018. Non-utility purchases made up a significant portion of the 2020 spot market activity.” – Cameco Q4 2020 MDA.

Enter SPUT.

In a mere 15 trading days, the fund managed to accumulate 6.6 million pounds in the spot market, equivalent to about 7.1% of last year’s volumes. The current run rate works out to 110 million pounds per annum (assuming 250 trading days a year), about 120% of last year’s spot market volume (which was in itself a record high).

Of course, this is on the strength of a meagre US$300 million ATM facility. What happens to the run rate when the ATM facility gets bigger? We’re about to find out. On Friday, SPUT amped up their attempt to corner the spot market by announcing a US$1 billion ATM offering. Uranium equities surged on the news and continued to surge on Monday (9/13). Twitter is rife with uranium bulls taking a victory lap.

Not my first rodeo

I have been covering the uranium trade for the past several years and I’ve seen how this kind of euphoria ends. In April 2019, I warned about not getting caught up in the hype around the Section 232 petition. I more or less got the top in UUUU and URG and avoided the meltdown in US uranium plays in July 2019. I jumped back in to the space with a swing trade going long Uranium Participation (now SPUT), Cameco and Ur-Energy in August 2019.

Most recently, I recommended shorting Cameco (CCJ) and the North Shore Global Uranium Mining ETF (URNM) on July 10, closing the trade after getting stopped out on 8/27 for a loss of 2.1% and 1.6% respectively.

On 8/23, I said: “I’d tighten my buy stop on URNM to around 57.5 and CCJ to around 17.75. The Sprott uranium ETF (TSX:U.UN) went up on announcing a $300 million financing meant to hoover up uranium from the spot market. There is a chance spot uranium rises dramatically if they succeed in cornering the inventory available for immediate sale. If it were obvious they would succeed, I’d say just close the short position now and get long again. Tightening stops just helps eliminate the guesswork and makes it a more systematic trade.”

In hindsight, I should have recognized that this was an asymmetric setup. If they didn’t succeed, I would have been out for a minimal loss.

Downside risk? Who cares?

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” – Citigroup’s Chuck Prince in reference to the subprime bubble in July 2007.

Hardly any of the bulls appear to be thinking about what could go wrong. I can think of numerous ways this ends badly.

  • The SEC calls for a trading halt on SRUUF, the US ticker for SPUT, while it investigates potential market manipulation. Buying up 7.1% of annual spot volume in 15 days while advertising intent to buy more can easily be construed as manipulation by the lawyers and bureaucrats at the SEC.
  • The provincial securities regulators in Canada do the same. I’m not an expert on which regulator would have jurisdiction over the trust, but presumably they can lean on the TSX to halt the stock while the matter is under investigation.
  • The US utilities file a lawsuit alleging market manipulation. They could make their case as follows: these Canadian financial market participants are seriously endangering American electric grid stability and increasing the cost of electricity for every American family. This is an issue of national security.
  • A major spot market seller (BHP?) calls SPUT’s bluff and agrees to sell as many pounds as the trust can buy at a trumped up price. For context, BHP’s Olympic Dam mine produced 7.2 million pounds of uranium in 2020. While this wouldn’t stop the momentum, it would stall the parabolic run up in prices while the fund digests the heavy supply. Since parabolic moves seldom end by consolidating sideways, this would imply a crash in the uranium equities riding SPUT’s coattails.

Flipping the uranium industry’s prior protectionist arguments

A legal attack on SPUT’s actions can rely on the same arguments made by the US uranium producers, but in reverse.

Historically, uranium market participants did not believe in free trade. During last decade’s bear market, uranium miners and consulting groups were trying to stop the US Department of Energy from transferring its UF6 inventory in exchange for clean-up and down blending services. Uranium market participants wanted to prevent the DoE from releasing about 6 million pounds per annum into the spot market because of the adverse price impact. They proposed several “solutions”, all of which involved hurting the DoE, utilities, and other participants in the nuclear fuel cycle. Their tactic failed.

In a 2015 report titled Secretarial determination for the sale or transfer of uranium, the DoE analyzed the effect of its activity on the uranium market, presumably in response to lobbying pressure exerted by uranium market participants.

Some relevant excerpts from the DoE report (feel free to skip):

“TradeTech’s report included an estimate that DOE’s transfers, at the 2,705 MTU per year rate, “could be the deciding factor” in whether a hypothetical miner continues production. TradeTech Report, at 22. The hypothetical mine has a marginal production cost of $47.41 per pound, a 50% exposure to the spot market price, and a long-term component to its realized price of $50. In addition, TradeTech assumes that the hypothetical mine requires a 10% margin to justify production. Observing that prices in the next couple years are forecast to range from $40 to $55 per pound, and that DOE transfers at 2,705 MTU per year would in TradeTech’s estimate reduce prices by on average $2.43 per pound, TradeTech concludes that the $2.43 per pound difference “could” matter for the hypothetical mine.

Some commenters characterized the TradeTech report as “overwhelming evidence” that DOE’s transfers are “threatening the very existence of several U.S. producers.” NIPC Comment of UPA, at 4. These commenters urged DOE to rely on TradeTech’s hypothetical example for assessing the consequences of DOE transfers for future production. NIPC Comment of UPA, at 7. DOE does not consider this example appropriate for that purpose and does not think it constitutes evidence that DOE’s transfers actually threaten the viability of U.S. producers, for several reasons. The analysis appears to compare current production costs at the hypothetical mine to near-term spot prices. DOE believes a producer would actually make its long-term investment decisions on the basis of expectations about prices over the longer term and the availability of long-term contracts at an acceptable price. TradeTech’s example does not reflect either of these factors. In addition, the hypothetical example uses assumptions that do not appear well justified. The hypothetical mine has average production costs of $47.41 per pound. There also appear to be only one or two projects, out of the number being developed in the United States, that have expected production costs near the assumed figure. The hypothetical producer also has long-term contracts at an average price of $50 per pound, just 5.5% higher than the producer’s assumed average cost. Yet, according to TradeTech’s hypothetical, this producer needs a 10% margin to justify production. This hypothetical producer would have needed spot prices to be not just 10% higher than its costs, but even higher ($54.30 per pound) to compensate for the low price of its long-term contracts. It seems unlikely a producer would actually have developed such a speculative project. In short, the hypothetical example as a whole is inconsistent with DOE’s understanding of how producers decide whether and when to invest in production resources.”

“Several commenters asserted that for a given amount of transferred uranium, introducing the material into the spot market is particularly harmful to industry. These commenters contend that DOE should analyze its transfers on the assumption that the material is primarily appearing on the spot market. They also urge DOE to take steps to ensure that the uranium it transfers is sold through term contracts, rather than through spot contracts or through future-delivery contracts that commenters say are little different from future spot contracts. Some of these commenters, representing members of the domestic mining industry, suggest that DOE could achieve this goal by distributing its material through uranium concentrate producers. These producers, the commenters say, have incentives to place DOE-sourced uranium into long-term deliveries, in order to mitigate the effect on spot prices. To the extent such an arrangement led to higher spot prices, DOE would also receive greater value for the uranium.

With respect to the impacts caused by DOE transfers, the foregoing analysis has, in almost all respects, assumed the material contributes to the spot markets over time. DOE therefore believes its analysis has comported with commenters’ suggestion. Assuming the commenters are correct that spot sales of DOE-sourced uranium are the most harmful way for the material to enter the markets, DOE has assessed the consequences.

DOE recognizes that if some or all of its transfers entered the markets through term contracts, the effects on spot prices could be smaller. However, for DOE itself to make transfers on the equivalent of traditional term contracts would not serve the purposes for which, in the main, DOE transfers uranium. In DOE’s understanding, a buyer on a term contract has a right to receive material at various future delivery dates; and it ordinarily pays for the material at or near the time of delivery, at a price determined by the contract. By contrast, DOE transfers uranium in exchange for services provided substantially contemporaneously with the transactions, not years in the future.

At least one commenter says that some utility buyers have the financial capacity to buy uranium and hold it for a few years before using it. According to the commenter, the price curve for uranium, coupled with the financial environment in which interest rates have remained very low, makes such transactions advantageous for utilities. DOE notes, however, that holding the material for a few years would not, apparently, serve the purpose of commenters who seek to remove DOE-sourced material from the spot markets. These commenters stress that what they consider the true term market involves deliveries five to ten years in the future. No commenter identified a person or group of persons that would have the financial wherewithal to pay the spot price for DOE-sourced uranium in the present and then retain the uranium for delivery that far in the future.

Commenters from the mining industry did indicate that they would be interested in managing the distribution of DOE-sourced uranium. However, DOE notes that the commenters appear to contemplate that DOE would receive in such an arrangement substantially less than the prevailing spot market price for the uranium. If, on the other hand, the commenters expect to pay prevailing spot market prices, DOE believes they could in principle already undertake to manage how the material enters the markets. DOE transfers uranium to commercial businesses; and one of them, DOE believes, sells its uranium to Traxys, a uranium trading firm. A person that wanted to buy uranium from DOE to transfer it from the spot market to the term market could buy the equivalent amount of material from Traxys instead.

For these reasons, while DOE is willing to explore whether it would be feasible for some persons, such as uranium concentrate producers, to manage the appearance of DOE-sourced uranium on the markets, DOE does not consider it appropriate to incorporate this suggestion in today’s determination.”

The report concluded thus:

“For the reasons discussed above, DOE concludes that transfers under the assessed case will not have an adverse material impact on the domestic uranium mining, conversion, or enrichment industries, taking into account the Russian HEU Agreement and Suspension Agreement.”

Note that the uranium miners and consulting groups made such a fuss over a mere 6 million ounces of DoE supply in the spot market. The same folks are now jumping with joy because the spot market is working in their favor. If the DoE adding 6 million ounces per annum to the spot market was not acceptable, by the same token, a closed end fund buying 6.6 million pounds over a mere 15 trading days should also be unacceptable. Except, now that the price is moving in their favor, this spot market participant is being encouraged.

A skilled litigator for the utilities only has to cite this report and argue the reverse. In 2015, the uranium miners claimed that supplying 6 million pounds of uranium per annum in the spot market was harmful to their industry. The same market now has a financial participant who has purchased 6.6 million pounds in 15 days and intends to continue purchasing as much as possible. This financial speculation is harmful for utilities which rely on the spot market to meet their reactor requirements. The DoE report notes that: “At least one commenter says that some utility buyers have the financial capacity to buy uranium and hold it for a few years before using it. According to the commenter, the price curve for uranium, coupled with the financial environment in which interest rates have remained very low, makes such transactions advantageous for utilities… No commenter identified a person or group of persons that would have the financial wherewithal to pay the spot price for DOE-sourced uranium in the present and then retain the uranium for delivery that far in the future.”

Translated, the uranium industry was unable to identify any market participant capable of buying spot inventory and holding for future delivery. In other words, utilities were reliant on the spot market for their purchases – the very market SPUT is now manipulating higher. Enough grounds for a lawsuit? I think so. It is hard to fathom how an entire industry thinks it can prosper by screwing their customers over, but that seems to be the underlying motive of the uranium market participants. 

Forget a lawsuit, all that’s needed is for utilities to refuse to be bullied into paying exorbitant prices and appeal to the DoE for help. The DoE has plenty of inventory to sell just for such exigencies. The precedent was recently set by the DoE in the oil industry. For the first time in four years, the Energy Department has authorized the release of some of its strategic oil supply to combat a significant fuel shortage in Louisiana following Hurricane Ida.

Will the DoE favor the miners and SPUT and hold off on inventory sales as the spot price soars, or will it help ease the supply situation by selling inventory to any utility that is in urgent need? No official at the DoE would want a journalist to print a story where the DoE puts financial gain for uranium investors ahead of America’s energy needs. This is partly why the Section 232 petition failed as well, in my opinion.

So, the grand SPUT corner may well end up with the uranium industry once again falling flat on its face.

Remember, the Hunt brothers didn’t succeed in their 1980 attempt to corner the silver market. Not because the path to success wasn’t clear – it was. They failed because the exchange deliberately changed the rules on them in order to stop them from succeeding. I expect SPUT to meet a similar fate.

If you’re betting on this parabolic trend to continue now that SPUT has an additional $1 billion arsenal, chances are you will be wrong.

Valuations don’t matter until the bubble bursts

To illustrate how crazy valuations have gotten, let’s look at Cameco. The stock has a current market cap of US$9.85 billion (9/13 close). If Cameco miraculously manages to get their mines out of care and maintenance tomorrow, they can produce 27.3 million pounds per annum (current 2021 guidance: 6 million pounds). Assuming all-in cost of $45/lb (2021 average unit cost of sales: $47-$48/lb), a mine life of 15 years, and a 30% haircut on operating earnings for G&A and taxes, the stock is currently priced for US$95/lb uranium. This is without considering upfront start-up costs and sustaining capex.

Uranium Price Assumption (US$/lb)$94.6
Total production cost (US$/lb)$45
Operating earnings per pound (US$)$49.6
Annual production (million lbs)27.3
Total operating earnings (US$ mil)$1,354.55
Net earnings (US$ mil)$948.19
Present value (5%, 15 years)$9,850
Current market cap (US$ mil)$9,850

Cameco is less richly valued than most equities in the uranium space, which indicates how ridiculous valuations have gotten already. Let’s not forget that uranium is only around $43/lb, less than half the implied price for which Cameco is currently priced. Crazy!

Bubble Dynamics

“Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It  represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited.” – George Soros

George Soros is rumored to have said that when he sees a bubble forming, he first tries to blow it bigger in order to capture the upside. Those are wise words to live by. However, the trick with bubbles is to get out in time – capturing most of the upside without being caught long when it implodes. Soros did this quite well too.

Sprott is a retail brokerage and asset management firm. The house view is to be long commodity stocks. Rick Rule, the former CEO of Sprott US Holdings, is a well known (and highly regarded) uranium bull with a large following. Harris Kupperman of Praetorian Capital, the one who penned the article “The New GBTC…” and talked up uranium equities on RealVision, has 28K followers on Twitter.

The marketing efforts of all the big names in the space has ensured enough buyers to fuel the bubble – so far. This is called creating a liquidity event. That’s when the buying volumes are high enough to absorb the huge sell orders from institutions with massive inventory, without moving the price around too much. Any professional trader worth his salt would see these volumes as an opportunity to cash out. If they aren’t already, they will be very soon.

The selling will be apparent on the tape only after the fact. Volumes will dwindle, the stocks will close at the lows of the day and the bids will slowly disappear. By the time the lemmings wake up to the fact that they are bag holders, the parabolic move would have substantially retraced, saddling them with heavy unrealized losses. Every uptick will be met with selling by disgusted investors using the higher prices to minimize their losses.

Charts: URG (top) and UUUU (bottom), a refresher on how the Section 232 hype ended in July 2019

It is no fun being a bag holder. The prudent thing to do is to take the money and run, giving up on the remaining upside, if any. I’m not in the business of calling tops but this sure isn’t going to end well for the johnny-come-latelys who are FOMOing into this trade.

Personally, I’ll be getting out of my last remaining uranium position anytime now and watch the fireworks from the sidelines.

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