-- Posted Thursday, February 17 2011 | Digg This Article |

BMO Capital Markets Mining Analyst Ed Sterck projects a very moderate $60/lb. uranium price in 2011, but that shouldn't stop you from investing in the uranium space. "This is a sector that is very prone to sentiment and, at the moment, the sentiment is building toward the possibility of a price spike," he says. He also expects to see more M&A activity in the sector, particularly among uranium juniors with reasonably priced projects. Read on for more of Ed's sector insights in this exclusive interview with The Energy Report.

The Energy Report: London, where your office is, is the financial capital of the world and uranium equities remain a large portion of your coverage universe. Could you tell us about the institutional investor appetite for uranium equities now and over the last four to six months?

Ed Sterck: Well, it's certainly picked up. When you look back 12 months, the uranium market was pretty uninteresting for the average institutional investor. Prices had remained fairly flat until about six months ago. Since then, obviously, the spot price of uranium has picked up markedly and with that, we have seen a return of investor appetites for uranium plays. I think that's slightly precipitated by people's recollection of the price spike of 2006–2007, and the response that company share prices demonstrated with the price spike. I think it would be fair to say a number of the investors looking at uranium again are hoping something similar will unfold.

TER: Are you seeing an increase to the $130/lb. range as was the case in 2007?

ES: My analysis is a little more subdued than that. I actually think that uranium supplies will be adequate for the next several years, and then enter into a deficit at the end of the current decade. If you were to look at the supply and demand picture as I see it, then I would expect the price to be determined by the marginal cost of production. On that basis, I am looking for a price of $60/lb. in real terms for the next couple of years, and then a little peak at $70/lb. in 2013 and 2014 before coming back to a long-term price of $60/lb. That said, the uranium market is small and very sentiment driven. So, there's certainly the potential for a price spike, perhaps regardless of the underlying fundamentals.

TER: You talked a little about institutional investors' growing appetite. Is there anything different about the types of investors entering the market this time around? Have you noticed anything unusual?

ES: No. I think it's a similar collection of people, though the generalist funds are looking at the uranium space at the moment. But I think there is a difference in the way investors are looking at each of the individual stock opportunities, certainly in terms of those companies that were exploration and development plays back in 2006–2007. Many of those companies are now in production, and I think there is more of a focus on companies producing meaningful amounts of cash flow. So, rather than just buying those stocks on the basis that the uranium price might go up, I think investors are being selective about which stocks they choose, expecting some stocks to actually have a great return for shareholders on a peak-cash flow basis.

TER: So the last run-up in uranium prices funded a number of projects, and the investors that got out of those stocks when uranium fell to below $40/lb. are coming back. But many of those projects are in production or coming into production and generating cash flow. So, those projects are far less speculative.

ES: They are probably far less speculative than they were in the past. What I was trying to angle at is that I think people were a bit less discerning about which stock they invested in back then—like anything with "uranium" in its name was worthy of investment given the price run-up. Now, investors are saying, "Okay, I expect this stock to outperform that stock on the basis that it's going to generate meaningful cash flow, whereas the other is going to struggle to give a decent return to shareholders."

TER: Do you think that's directly as a result of what happened in 2008?

ES: I think you've raised a good point there, and I think that it probably is. Some investors did get their fingers burned last time and perhaps now they are being a little more cautious. You know, once bitten, twice shy.

TER: Do you see consolidation on the horizon in the uranium sector, or is that a little farther off?

ES: No, I think that will be one of the big themes this year, though I anticipate it will be the large- and mid-cap guys consuming some of the smaller companies with good projects. In terms of the bigger companies, there might be acquisitions or a merger of equals but I think both events are unlikely. Acquisitions of mid-cap companies are more likely to come from higher up the food chain, perhaps by the power utilities, principally out of Asia, looking to secure production, who may be thinking, for example, "China's got a very ambitious nuclear growth program, which will require uranium to fuel it. Rather than buying a project and developing it ourselves, perhaps we should just go and buy current production."

TER: Do you expect M&A activity to be geographical in nature? Or should we look for more diversification in terms of exposure to uranium in a given locale versus another?

ES: Well there are a limited number of countries in the world that have economic uranium deposits at the current uranium price. Probably what we'll see is more people looking to acquire projects in areas that, in the past, faced political opposition to uranium mining but now are allowing mining. An example would be Western Australia where there are numerous juniors with small- to medium-sized deposits that might be available for a reasonable price. That's one of the things we could see happening.

There's also some interesting exploration happening in places like Mali and Botswana. We could see people looking to pick up some exploration portfolios hoping to find a new uranium-producing district. On the other hand, I'm not sure the senior companies are prepared to pay any price for assets. Historically, M&A across all commodities tends to be fairly price sensitive. If the market speculation that's building with the current increase in the uranium price translates into large market valuations for some of these projects, then they might not be that appealing to the seniors and mid-cap producers.

TER: But you're predicting $60–$65 uranium four years out, so it seems like the price will be fairly static.

ES: Yes, but by using my assumptions for production and sales, I can roughly calculate the implied uranium price the market is paying for uranium stocks. In most cases, it's significantly higher than the current uranium price. We're talking +$100/lb. for current producers and $60/lb. for exploration stocks, because the market's expectation is that uranium prices will continue to rise. Exploration stocks imply slightly lower uranium prices because the market is discounting development risk. However, if prices stay at $60–$65/lb. in real terms for the next four years, the market tends to get bored with things staying static, and I think we would probably see a reduction in those premiums. If I was a mid-cap producer with my price outlook—and I don't think any of them share it—I would probably choose to sit on my hands and wait to pick up assets at a cheaper price.

TER: Has there been a noteworthy increase in uranium juniors seeking financing for uranium plays, or do you think there will be?

ES: We haven't seen a significant amount yet, but given the uranium price rise and increasing investor interest in the space, we'll likely see a pick up in the number of juniors looking to capitalize on their higher share prices in order to raise capital.

TER: Please leave our readers with some of your thoughts on the uranium sector in 2011.

ES: As you know, I'm pretty cautious on the uranium price outlook. As I mentioned, this sector is very prone to sentiment and, at the moment, sentiment is building toward the possibility of a price spike. I'm telling my clients this is not a sector that I anticipate pulling back significantly—unless the uranium price gets too far ahead of the underlying fundamentals. It might not be a bad place to park any spare cash investors may have because they're unlikely to lose a significant amount of money by investing in the space, given the current sentiment.

TER: Thanks for talking with us today, Ed.

Edward Sterck covers uranium, diamond and platinum group metal mining companies for BMO Capital Markets. He joined BMO in 2007, prior to which he was a mining analyst at Hargreave Hale. Before working in mining research, he spent more than four years trading government bond futures on a proprietary basis. Edward holds a bachelor of science in geology with honors from the Royal School of Mines, Imperial College London.

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-- Posted Thursday, February 17 2011 | Digg This Article |