Where can investors turn when global quantitative easing and the Energizer
Bunny of dollars is crushing commodity prices to within an inch of the junior
miners' lives? In this interview with The Mining
Report, Disruptive Discoveries Journal writer Chris Berry
suggests dedicating yourself to understanding the technologies and paradigm
shifts that can lower costs, and participating in the growing electric car
and energy storage battery markets. He names some of the innovative companies
that are finding new ways to separate the most valuable resources and enter
the supply chain before it is too late.
The Mining Report: You have talked in
the past about the epic macroeconomic battle being waged between inflation
and deflation. What are the indicators you are watching and where are we
headed?
Chris Berry: Right now, the scales still appear to be tipped toward
deflation, but that's not uniform across the globe. It still appears that
disinflation is the predominant force: There is evidence of economic growth,
but productivity is stagnating and living standards are moderating as we
haven't seen the "escape velocity" growth necessary to start a new
economic cycle. The excess supply in many commodities like iron ore is
referred to as "good" deflation. However, savings rates are up and
consumer demand is lagging. This is "bad" deflation. According to
economist Gary Shilling, both of these are happening today. It appears that
economic liftoff has been postponed. The secular stagnation thesis put forth
by Larry Summers looks increasingly valid.
Disinflation is one of the reasons commodities, metals in particular, have
been under pressure for the last couple of years. Globally, central banks
have embarked on unprecedented measures, including quantitative easing (QE),
to kick start their economies. The QE program in the U.S. has ended, but the
results are mixed. Unemployment has fallen precipitously, but concerns over
wage gains and the "types" of jobs created linger. The Federal
Reserve, in particular Chairwoman Janet Yellen, seems intent on a Fed Funds
rate increase, but precisely when is a moving target. Given the recent
softness in economic data in the U.S., a rate hike could be pushed to the end
of the year as opposed to June, which is when many were thinking it would
happen.
The Eurozone has embarked on its own version of QE to the tune of about
€60 billion a month, and Japan has been involved in its own QE program of
unprecedented size. In short, no intervention of this type has generated the
2% inflation target that central banks are targeting. It appears that they
are running out of tools to ignite escape velocity growth. If you think of
debt as future consumption denied, then deleveraging obviously still has a
long way to go before a new credit cycle can begin.
Around the world, inflation appears dormant for the moment. Rates in many
parts of the world are actually negative, specifically in Europe. What this
means is that you, as an investor, pay the government to lend it money, a
phenomenon known as financial repression. This policy is intended to
discourage saving and encourage consumption and spending. When we observe the
beginning of the formation of a normal yield curve, we will have the first
sign that the commodity cycle is indeed turning. It just doesn't appear to be
imminent right now. The problem is secular and not cyclical.
Additionally, U.S. dollar strength has put a lid on commodity prices. As
you can see below, the U.S. dollar (shown in white) has gone parabolic since
last year against other currencies. There really is no need for the Fed to
tighten as the stronger dollar is in itself a tightening measure for the U.S.
economy.
The U.S. dollar has taken a little bit of a breather, and that's why we've
seen a floor in some of the commodity prices, in particular gold (shown in
orange). Copper seems to have bottomed nicely, which is a positive. But
because many commodities are priced in U.S. dollars, they become more
expensive in other currencies as the U.S. dollar strengthens.
U.S. Dollar
and Gold
Source: Bloomberg
TMR: Will some commodities prices turn faster than others?
CB: The global economy is dealing with the excess capacity built up
during the commodity supercycle in the last decade. This excess capacity will
eventually be consumed, but it's going to take time, and it's going to vary
from metal to metal.
Some of the energy metals—any metal or mineral used in the generation or
storage of electricity—are growing well above global gross domestic product
(GDP) and aren't flooding their respective markets in the way that iron ore
is. Examples include lithium, cobalt, vanadium, scandium, rare earth
elements, uranium, and copper. I think this value chain is going to be an
enormously profitable sector in the coming years. There is overcapacity in
some energy metals today, but pricing, while soft, has seemed to stabilize.
In these smaller markets where many prices are negotiated from sale to
sale, there is less elasticity than with other more liquid markets. Both
lithium and cobalt are well supplied, just as base metals are. But lithium
demand is growing at 8% and cobalt is growing at 6–7%. This has been fueled
by a number of different catalysts including advances in technology and
lifestyle changes that are pushing energy metals to the forefront. That said,
it will likely be two or three more years before these markets equilibrate
and we see stronger upward pricing pressure in these markets.
For any junior looking to be acquired, its financial metrics MUST match
that of a major producer. For example, if a lithium junior is hoping to be
taken out, it would need to show economics as strong as or stronger than
anyone in the existing oligopoly. So if FMC Lithium Corp.'s (FMC:NYSE) EBIT
margin on its lithium business is 10%, any lithium junior must show a margin
of AT LEAST 10% to even be considered. With many of the juniors producing
preliminary economic studies, it's too early to tell which will be acquired
and which will be forced to go it alone, as the economics in these studies can
vary widely.
TMR: A lot of the energy metals growth is connected to electric
vehicle (EV) batteries. You have been skeptical of Tesla Motors Inc.
(TSLA:NASDAQ), but the cars are so sleek and cool looking. What makes you
think the demand for electric cars may not be as phenomenal as the headlines
make them out to be?
CB: You're correct when you say that much of the growth in energy
metals demand comes from batteries. Outside of batteries, much of the energy
metals growth is slower—tracking GDP. It's very encouraging that battery
costs are falling by 7% to 8% per year. Should this continue, it's not that
hard to see how vehicle electrification will become more ubiquitous in the
coming years. With respect to Tesla, I'm really questioning the valuation.
What troubles me most about Tesla is that it appears to be priced for
perfection. Dozens of major automakers like Mercedes-Benz, BMW, General
Motors and Ford are entering the market with their own electric or hybrid
vehicles and prices are bound to fall. That's good for consumers, but a real
challenge for automaker margins. Additionally, with mileage standards for
internal combustion engine autos also increasing, EVs of all types are really
going to have to enhance their overall economics to go mainstream.
Much of the value created so far in the battery supply chain hasn't been
in the automotive space. It's been in the actual battery manufacturing niche.
Samsung SDI Co. Ltd. (006400:KRX) purchased Magna International's battery
pack division and Asahi Kasei purchased Polypore International Inc.
(PPO:NYSE) in recent weeks, all with the intention of fortifying their own
battery businesses. I expect to see more consolidation like this higher up on
the value chain.
We've also seen some interesting deals at a smaller scale with the British
vacuum cleaner firm Dyson investing $15 million ($15M) in Sakti3, a small
U.S.-based tech firm pioneering solid state lithium-ion batteries. This last
point speaks to something that makes me somewhat nervous with the lithium-ion
battery business as it exists today. As technology pushes forward and demand
for smaller, more powerful devices increases, today's technology may not be
the optimal technology in five year's time. Given this reality, the large
battery factories currently under construction will need to be able to shift
their production processes should technology shift. Ultimately, the question
of raw material access will come front and center, but right now, major
corporations haven't publicly considered it to be a significant issue.
The real driver for battery growth won't be vehicles—it will be energy
storage. When we look at the rate of growth in solar power adoption, the
costs are crashing through the floor—an example of good deflation. Over one
third of new electricity capacity in the United States in 2014 came from
solar and, since 2010, the average price of a photovoltaic module in the U.S.
has dropped by 63%, according to the Solar Energy Industries Association. As
costs per watt continue to fall, photovoltaic installations are forecast to
double in the U.S. in the next two years, to approximately 40 Gigawatts. The
growth in other parts of the world is equally impressive. The natural step to
get around the intermittency of renewable power is storage through batteries.
I'm excited about the pace of innovation in the battery sector and think that
this may ultimately be where Tesla has a substantial impact.
TMR: What are the mining companies that could supply the battery
manufacturers with cobalt in the near- and medium-term future?
CB: I've previously discussed the leading junior cobalt players,
which are Global
Cobalt Corp. (GCO:TSX.V), Formation Metals Inc. (FCO:TSX) and Fortune
Minerals Ltd. (FT:TSX). They each have a reasonable chance of integrating
into global supply chains over the next few years. Right now, my focus is higher
on the value chain. I pay particular attention to what a company like Glencore
International Plc (GLEN:LSE), Freeport-McMoRan
Copper & Gold Inc. (FCX:NYSE), Vale S.A.
(VALE:NYSE) or Sherritt International Corp. (S:TSX) is saying and doing.
Is it working to increase supply and capacity or does it not view cobalt
supply as something it needs to worry about? You don't want to take your eye
off of the juniors by any stretch of the imagination because in a few years
they are going to be the next suppliers.
Another area to consider is recycling. I have long thought that cobalt
could emerge as a pinch point for battery supply chains due to availability
stemming from geopolitical issues and the fact that cobalt is mainly a
byproduct. Should we see sustained higher cobalt prices, recycling could
become more prevalent. It's a remote possibility, but one worth considering.
A final note on cobalt: One of the real challenges with the energy metals
space is that the pricing is opaque. A lot of it is determined based on
handshake agreements and much of the publicly available pricing data is only
indicative. Cobalt futures contracts are listed on the London Metals
Exchange, so you can monitor what speculators and hedgers are thinking by
studying the futures markets 12 to 18 months out. The cobalt futures curve is
in backwardation right now, meaning that futures market participants are
expecting higher cobalt prices in the future. There are a number of reasons
for that, but the battery market growth really underpins it.
TMR: What are the sources outside of China that could supply
lithium for battery manufacturing?
CB: The question is who can supply battery grade lithium—either
carbonate or hydroxide—at a price competitive with the oligopoly? The majors
such as Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX;
SQM-A:SSX), FMC Lithium, Albemarle Corp. (ALB:NYSE), and the Chinese are able
to supply the market and it appears that there is evidence of excess supply.
Should lithium demand continue at its current pace, this excess will get
mopped up over the next couple of years and therein is the window for new
entrants. Orocobre Ltd.'s (ORL:TSX; ORE:ASX) performance this year should
tell aspiring lithium juniors all they need to know about the state of the
market and how easy or difficult it will be to integrate. Lithium is another
one that I think has a positive future. It is oversupplied right now. It's
probably going to be a couple more years before that balance tips. The
companies that I'm looking at right now are actively employing some sort of
technology or strategy to lower costs and become more attractive, either as
acquisition candidates or in order to raise financing.
I've discussed Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX) previously
and its relationship with POSCO (PKX:NYSE). The demonstration plant POSCO has set
up at Lithium America's Cauchari salar in Argentina has met or exceeded
expectations to date, having produced 6 tonnes of lithium compound last I
heard. The material was sent back to POSCO in Korea for further testing and
should be sent to potential end users to gauge suitability in end products.
The technology POSCO is employing, as I understand it, is designed to enhance
recovery rates, dramatically shorten the time it takes to produce lithium
from brines, and do so with a dramatically smaller environmental footprint.
If successful, this technology could upend the lithium market by reducing
costs.
Lithium Americas and POSCO aren't alone. Some of the other lithium juniors
pursuing a low-cost production strategy through technology include Stria
Lithium Inc. (SRA:TSX.V), Pure Energy
Minerals Ltd. (PE:TSX.V), Nemaska
Lithium Inc. (NMX:TSX.V; NMKEF:OTCQX) and two private entities I am aware
of. Some of this technology is geared toward the hard rock production of
lithium and, while details are sparse, I think it's hugely important to watch
each of these for success or failure. Of course, an unforeseen issue of
technological success could be a flooding of lithium on the markets driving
down the price. At this point, I'd say that's a remote possibility, but one
that can't be dismissed out of hand.
TMR: Nemaska is focusing largely on lithium hydroxide and has its
own pilot plant that it is building. Could that be a differentiator for the
company?
CB: It definitely could. Some of the research I have done indicates
that lithium hydroxide is preferable to lithium carbonate with respect to
durability in the battery and that's why we're starting to hear more about
it. Nemaska is forecasting production of both lithium hydroxide and lithium
carbonate to diversify supply somewhat. At current prices, lithium hydroxide
allows for wider margins.
One other company that comes to mind for diversifying your product mix is Western
Lithium USA Corp. (WLC:TSX; WLCDF:OTCQX). Its Hectatone business, which
supplies what is known as organoclay to the oil and gas business, is ramping
up, having sent its first shipment earlier this year to an end user. That
production offers it a nice hedge and a separate revenue stream as it works
toward getting its lithium business up and running. Western Lithium has also
discussed recent success with continuous production of high purity lithium
carbonate at a demonstration plant it has constructed in Germany. The company
is also actively researching the lithium hydroxide processes and will
continue pilot plant optimization to produce samples for potential customers.
A final company poised to benefit from the idea of optionality is Galaxy
Resources Ltd. (GXY:ASX; GALXF:OTCMKTS). The company has recently closed
on the sale of its Jiangsu lithium carbonate plant and now will have
something in high demand in the mining business—cash in the amount of
approximately AU$30M. Galaxy has also entered into a binding agreement with a
company named General Mining Corp. to have it produce tantalum from the Mt
Cattlin mine for a period of three years with the option to purchase the mine
for AU$30M. Galaxy will generate cash—approximately AU$2.5M per year—plus a
royalty from this agreement. There is more detail here, but I wanted to use
it as an example of how optionality in the metals sector is a key strategy at
this point in the cycle. Galaxy can go in a number of different directions.
TMR: What are the other energy metal raw materials that we should
be watching?
CB: I'm particularly interested in scandium. While lithium and
cobalt are the 800-pound gorillas in the space, scandium is much smaller and
is misunderstood, I think. Though estimates vary, scandium is widely believed
to be a 10 to 15 tonne per year market—that equates to about $40M. Once the
potential for scandium is discovered, things will get very interesting and
the market size could be multiples higher.
TMR: Scandium is used in advanced aircraft and metal halide lamps.
What is the shape of the resource market and who are the promising players?
CB: In addition to my previous comments, there is no primary
scandium mining anywhere on the globe right now. It's produced as a byproduct
in China and sourced from stockpiles in other parts of the world. Much has
been written and published around the use of scandium in solid oxide fuel
cells and also as an alloy with aluminum. A Google search for "Scandium
patents" or something similar will validate this claim. So the issue
isn't potential demand; it's security of supply. It's a real chicken-and-egg
quandary. Financing scandium projects will remain a challenge until people
are convinced of a growing end market, but those end markets can't grow until
reliable supplies are on stream.
One of the companies I have focused on is Scandium
International Mining Corp. (SCY:TSX), formerly EMC Metals Corp. The
company recently signed a memorandum of understanding (MOU) and an offtake
agreement for 7,500 kilograms per year of scandium starting in 2017 with a
private Canadian company. If you assume a $2,000 per kilogram price for
Scandia, which is what is assumed in Scandium International's preliminary
economic assessment (PEA), it's not hard to see how it could become a
powerful force in the global scandium market given its current size of
approximately $40M.
TMR: Did the market recognize the importance of the MOU and the
offtake agreement for Scandium International?
CB: No, I don't think so. I think a lot of people are still
learning about the scandium market and its potential. That's one of the
reasons why I'm so optimistic about it, because it's not well understood.
Again, a closer look at the potential math here tells an intriguing story.
Additionally, the company is working on optimizing its flow sheet, which
should improve what are already strong economics at the PEA level. It does
have $2.5M of convertible debt on its balance sheet. That comes due at the
end of 2015 and needs to be addressed. The company can wipe the $2.5M in
convertibles away and strengthen the balance sheet by raising $3M in equity.
TMR: The other metal needed for batteries is graphite. What are the
prospects for that market and companies in that space?
CB: I'm following graphite, but I'm not as bullish on it as I am on
some of these other resources that we've talked about. My sense is that too
many juniors are focused on the EV market and would be better served by
attending to some of the "less sexy" uses for graphite. The market
is fragmented from a production perspective, which I think is a good thing if
you're a junior or an aspiring producer. But I'm much more focused right now
on what a company like Imerys (NK:PA) or SGL Carbon SE
(SGL:XETRA) is saying or doing in this space or AMG Advanced
Metallurgical Group N.V. (AMVMF:OTC), a Dutch graphite producer. What is
it saying? What is it looking at? Where is it going? Furthermore, what is
happening with the long rumored closure of mines in China? AMG's recent moves
into Africa are a possible signal of expansion plans or opportunities in that
part of the world. Some of the recent offtake agreements announced by
aspiring Australian graphite juniors truly make your eyes pop out of your
head and bear closer attention as the dust settles and we learn about them in
more detail.
Graphite isn't all that different from lithium in that I think the
lowest-cost producers are best positioned to ride out the current malaise in
the markets. I'll be watching the performance of Flinders
Resources Ltd. (FDR:TSX.V) closely, as the company has successfully
achieved production. Going deeper into its financial performance can offer a
valuable insight into what the market holds for the optimal North American
juniors such as Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX) or
Focus
Graphite Inc. (FMS:TSX.V; FCSMF:OTCQX; FKC:FSE). In graphite, you need to
be able to produce a product to the exact specifications of a given customer
and do so profitably. A unique strategy may also be creating a company's own
high-tech supply chain, which Focus is aiming to do through a private
subsidiary. This way, a company is not just subject to the cyclicality of the
mining business and can enter higher margin businesses.
TMR: Rare earth elements (REEs) are used in a lot of new
technologies, including batteries. Will non-Chinese REE companies start to
come into their own as China begins to focus on its environmental challenges?
CB: That's the thinking in the investing community. I'm inclined to
agree with that with one major caveat. One of the things we've learned in the
last five years as REEs have come to the forefront is that all deposits
aren't created equally. It seems that every time I turn around, there's a new
acronym to describe a deposit and what differentiates it. First, it was light
versus heavy REEs, then it was critical REEs. Soon, it will be something
else.
We have learned over the last five years that the technology used to
extract, separate and purify the oxides is critical. As rare earth prices
crashed, this became and remains painfully evident. In the same way that the
right lithium production process can lower lithium extraction and production
costs, a number of emerging technologies in the REE space can perhaps do the
same thing. At the end of the day, we will still need to compete with China
on price.
TMR: What are some of the companies that could benefit from these
changing demand structures and the development of affordable separation and
refinement technology?
CB: One that comes to mind is Ucore Rare
Metals Inc. (UCU:TSX.V; UURAF:OTCQX). The company has been active in
researching different extraction technologies in recent years, and it has
recently acquired the rights to a process known as Molecular Recognition
Technology (MRT). This technology was developed by a private company called
IBC Advanced Technologies and through a joint venture with Ucore will allow
it to pursue the separation of REEs on a molecular level. Ucore has been able
to separate REEs at Bokan Mountain, as the company recently reported that it
had separated the entire suite of REEs at high purity utilizing this
separation procedure. MRT is currently used in copper refining by ASARCO LLC
(AR:NYSE), so the technology is not new at all. Ucore's next challenge will
be scaling this process up and proving out superior economics.
One other one to watch is Commerce Resources Corp. (CCE:TSX.V; D7H:FSE; CMRZF:OTCQX),
which is home to niobium and tantalum in the Blue River project in British
Columbia and REEs in the Ashram project in Quebec. As the company ramps
toward the feasibility stage, it has been focused mainly on optimizing the
flow sheet at Ashram and has recently been able to significantly reduce
consumption of primary flotation reagents at bench scale. This is important
as it will help drive down costs and enhance economics. The tantalum is sort
of a secret weapon and dovetails nicely with the theme of optionality I spoke
about earlier. It gets overlooked and isn't really factored into the current
valuation of the company, but it could pay off in the long run.
TMR: We have covered a lot in the energy metals space. Some of our
investor readers have been very stressed watching some of the prices lately.
What words of hope and wisdom do you have for them?
CB: I have been stressed, too, so know that you are not alone.
During the first decade of this century, we all benefitted from the commodity
supercycle, the likes of which many of us had never seen before. Now that
growth has slowed, it's forcing us all to adapt and re-examine our
expectations and approach. But even while some of the macro headwinds I
talked about at the beginning of the interview are still visible, there is
cause for optimism. The global economy is still growing overall and
technology is advancing at an ever faster pace. I don't think investors
should throw the baby out with the bath water and disregard commodities out
of hand because this cycle will turn eventually. What we're experiencing now
calls for a more innovative or creative approach to investing in metals.
It is more important than ever to find the low-cost, sustainable
opportunities. Right now, a lot of them are leveraging technology to lower
costs and enhance returns. I would temper your expectations for short-term
exponential gains. You have to have patience to be in the junior space right
now, but ultimately it will be vindicated.
TMR: Thank you for your time, Chris.