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February 24, 2019 20

LITHIUM’S SECOND COMING

Spodumene processing at Altura Mining in Western Australia

If you invested in Lithium stocks back around 2015, you also watched the hype build, culminating in very high valuations by 2017. What was quite obvious at that point, is that prices were driven by what might be, rather than any factual basis. Lithium stocks were simply over-valued at the time based upon hype.

Prices then corrected in 2018 amid talk of an over-supply. One particularly famous comment of ,”a tsunami of over-supply”, was rightfully ridiculed. However, few had worked out the effect of new supply coming online from mines such as Altura and Pilbara Minerals. We believe they fell under the radar because much of the reporting was U.S based, and Western Australia was largely overlooked. The market was simply used to estimating based upon traditional South American brine producers.

How great the oversupply is a complex question due to the entry of sub-standard materials and a lack of processing. The degree of over supply depended on the origin and quality and so effected some more than others. Lithium was no longer a one size fits all market.

What happened in 2018 now leads us into 2019 and beyond. There are lessons to be learned, some of a general nature and some unique to lithium.

2019-altura-mining

A Cycle, Not a Crash

New mines get built when there is a need. Often not until that need becomes obvious enough to those that will fund the mine. Only then are they prepared to take the risk. The excitement of shortages and high prices increases market capitalization and creates the environment to entice funding. In the opposite manner, oversupply, whether real or imagined, reduces the funding of new mines, investor confidence and market capitalization. This is exactly where we are right now. You take a mouthful and you need to swallow it before the next. It is not a lithium crash, rather a normal cycle in mining

Why Lithium is Different?

During a normal cycle in mining the implications for lithium are vastly different to other mineral or metal cycles. What I struggle with, are very experienced analysts that treat Lithium just like other minerals or metals. Quite simply it is not another iron ore as many would suggest. In fact, it is a polar opposite. Iron ore crashed based upon stockpiling together with a contraction in demand and added supply.

How long-term investors could seriously consider lithium in this way is beyond me. Despite some oversupply and price retraction, the growth in lithium during 2018 has been astounding. Analysts from the big investment banks obviously missed disruption when honing their analytic skills. Bloomberg New Energy get it, but most do not.

Investor Pain

Every investor in the lithium market was hurt in 2018. We tried to minimize the pain but avoiding it while staying in the market was not really possible.

There are a few things that baffle me about investors. While claiming to be long term, they tend to live in the moment. If you make that mistake what you actually do is apply a day traders’ mentality to a long term investment strategy. This leads to making decisions based upon greed and fear rather than factual foresight. Both greed and fear have long term effects on how we invest based on reality and long-term fundamentals.

The Next Cycle

While some lament the damage to their portfolio during 2018, I consider it a time of reflection and preparation for the next cycle. The fact that the market has applied normal mining cycle rules to lithium, will mean that the next cycle will be closer than we think. Projects that needed to start in 2018 for production in 2021 have stalled. This, I believe will create another hole in supply and subsequently the next wave in the cycle. When deciding upon a cycle strategy, my focus is on identifying who is comparatively undervalued, and positioning a portfolio to take maximum advantage.

I can’t turn back some of the damage in 2018. What I can do is to increase and reorganize my portfolio at what now appear very low valuations for some stocks. When the next up cycle comes, I’m now well prepared to capitalize upon it.

The Truth of Supply & Demand

It feels like every analyst has a chart that shows their idea of growth in supply and demand. I regard most of them as total nonsense. Their rules simply do not apply while we are at the very beginning of a disruptive cycle. They have no idea which mines will begin over coming years, which are most likely, and how technology will shift. On the demand side they are hopelessly inadequate. The rules they apply are not disruptive rules.

There will be a certain number of tipping points as we move through the cycle. These points will create hype and at times massive hype. I don’t care what mathematics they apply, everyone gets infected by hype, from investors to mines, processors and manufacturers.

In addition, when we attain a certain level of hype suppliers of lithium begin to stockpile waiting for higher prices to sell. This adds more pressure to the supply chain in an up cycle and causes additional damage in a down cycle.

They totally miss the concurrent demand, supply chain surety and stockpiling and always have. For that reason, I’m not going to apply charts to supply and demand here.

If you must read them, I consider Bloomberg to be the standout and in fact just about the only one I give more than a cursory glance.

Loading of spodumene concentrate

What to Look For?

As investors ourselves with a great interest in new energy we’re looking for hype, spikes, media awareness and consumer sentiment. The new energy story is already certain to be massive and break all the rules of the analysts. We want to go one step further where we calculate the maximum infection point. The height of the fever. Sentiment will never stop working in cycles much as mining does. I think that maximum effect comes more from the sentiment cycle than the mining cycle because mining for new energy will never really keep up with demand for more than a short time.

When Will it Happen?

We’ve always stuck our neck out. We called the effect of electric buses in China well before most others. We also called some oversupply in early 2018. I may live to regret it but I ‘m now calling the second round to begin around October this year. The reality of tight supply is likely mid-year, but media surrounding China incentives will likely trick the market momentarily.

This will push the realization we are entering another very significant cycle to late Q3 or Q4. It’s not fact, attempting to read the market ahead is just what we do. I also believe this one will last longer and build higher than the last, from early beginnings in Q3, 2018 right through to 2021. When it does happen, new mines will be funded, giving new supply and inevitably another price correction. I’m currently positioned for the next spike and I’m well prepared for it. That to me is what investing for maximum gain is all about.

BYD leaders in electric buses

Where are the Facts?

Sadly, any meaningful facts are limited. Try looking back at the first motor cars, aircraft, computers, mobile phones etc and see what facts you can find. Every analyst got it wrong and so they shall this time. As optimistic as I am I also take comfort that I too, will likely miss the real level of disruptive growth. For those that do not believe we are entering a disruptive period this article will have little value. They should look elsewhere for the multitude of charts and opinions on likely growth cycles.

I would ask, how many advertisements have you seen on television for electric vehicles? Can you imagine how powerful they will be? How many dealers have you visited to see a line up of electric vehicles alongside ICE’s? How big do you believe the effect on massive grid scale and domestic storage will be? How many of you and your friends’ cars could currently be replaced with an electric vehicle? How will the combinations of secondary markets like LSEV’s, garden tools, shipping, boats, trucks, vans, drones, e-cigarettes, robots etc effect demand?

There are simply so many factors that will determine the next spike and we watch and calculate them all rather than play with some very nice charts.

Then there is the big one. They missed it last time and they will miss it again. Supply and demand is partially irrelevant. The big one is supply chain surety and it’s worth as much consideration as actual usage in analyzing spikes, yet missing from their equations. It’s hard to believe that’s what we get from professional analysts.

When the hype begins, the factories begin and the E.V manufacturers ramp up. The first thing they think of is ,”supply chain surety”. You do not commit to billions of dollars and buy lithium this week for sales next week. I mean really, do they think a billion-dollar gigafactory opens with enough lithium purchased each week for their needs. They will need many months of supply and that will be duplicated across countless projects, and by countless E.V manufacturers worried about the scarcity of supply. So much material is soaked into the supply chain never to really return to their precise charts. I never doubt for a minute that hype along with supply chain surety and stockpiling are the big ones.

Hyundai Kona compact SUV EV

Who Will be the Winners?

We do not discuss or recommend specific stocks What I think we saw in 2018 was a re-positioning of the market as battery technology matured.

I believe we will see spodumene concentrate emerge even more as the favoured source. In 2018 we saw brine producers move to hard rock investment and I think there are compelling reasons why. Not just the cheaper path to the higher growth hydroxide market, jurisdictional security, low exposure to weather events and proximity to the main market in China. Quite simply it’s a supply you can count on with obvious advantages. I expect that the hard rock mines from Western Australia will be an amplification of the overall success of the lithium market.

Roll on Late 2019

In summary we’re calling the start of a resurgence in mid to late 2019. I see all of the factors we track coming to fruition. New product from Altura, Pilbara and others will be digested ready for the next bite, which means expansion, or the establishment of new mines. There are few quality hard rock resources left in the world. Some are isolated and will take many years to begin production although the best will happen and are likely to come online around 2023, just as we enter the eye of the disruptive storm. Others will increase output but existing producers will struggle to satisfy the beast.

2019 will be a first for EV’s. China will continue to lead while others will make up ground. For the first time we’ll see some choice in the lower end market. We’ll see our first television advertisements while lithium and new energy will be the buzz word throughout the media. By 2020, I see a likely flurry of new projects attain funding and current producers and investors will quickly forget the pain of 2018.

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