George Topping: Sovereign Stockpiling Underway

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With the prospect of 30 million pounds of uranium evaporating from the supply lines four years hence, Blackmont Capital research analyst George Topping sees sovereign stockpiling already beginning to make itself felt on the demand side of the equation. In this exclusive interview with The Energy Report, George says he sees the price nudging up to $65 by the end of this year, then to $70 in 2010, $80 in 2011 and $100 within five years.

With the prospect of 30 million pounds of uranium evaporating from the supply lines four years hence, Blackmont Capital research analyst George Topping sees sovereign stockpiling already beginning to make itself felt on the demand side of the equation. In this exclusive interview with The Energy Report, George says he sees the price nudging up to $65 by the end of this year, then to $70 in 2010, $80 in 2011 and $100 within five years.

The Energy Report: Letís begin with some of your thoughts about uranium. Almost two years ago, spot prices hit a record $137 per pound. A year agoówell before the bottom fell out of virtually all the marketsóthe spot price dropped by nearly half, to the neighborhood of $70. You focus a lot of your attention on uranium. How do you see its future shaping up?

George Topping: The situation right now is youíve got the spot price down at about $43 a pound and the term price up at $69. Historically, the spot and the term price have traded very close together, within a couple of dollars. The hedge funds being forced to sell material in the spot market, which is typically a fairly small market for uranium, have depressed the spot price. But I expect thatís starting to dry up and over the next several months we should see the spot price come up to meet the term price round about the $60 to $65 per pound level.

From there I would expect it to increase further over the next several years, the main new source of demand being sovereign stockpiling. In the last five months, India has rejoined the nuclear club. India had been excluded for decades for political reasons. So with the Indians now having access to the uranium markets, I think theyíll be stockpiling a very large dump of U3O8 to power their nuclear programs, both atomic weapons and domestic power.

TER: What sort of balance is there between nuclear weapons and power plants? It seems it would be somewhat small for weapons.

GT: It depends upon how much test work is undertaken and how large a stockpile of nuclear weapons one requires. For example, over the last 10 years about 30% of the world nuclear power demand has been met by dismantling nuclear weapons and from Russiaís stockpiles. Thereís only a small amount of radioactive materialóand itís not commonly uraniumóin atomic weapons. But itís so pure and highly concentrated that you can blend it down to make an awful lot of fuel for power generation. Power reactors use pretty low-grade uranium; whereas a nuclear weapon is 99% pure.

TER: You used the term ďsovereign stockpilingĒ of uranium. So India isnít the only country doing the stockpiling.

GT: No. And it isnít only uranium. The Chinese, for example, have said that theyíre obviously stockpiling oil right now. Theyíre actually just commissioning one of the worldís largest storage facilities for oil. In the same announcement, though, the Chinese said that theyíd be stockpiling oil as well as other forms of energy. They have coal already and natural gas is not easy to store, but uranium is one of the easier ones to go out and buy and stick away in a strategic stockpile. Given that China has quite an aggressive build of power plants over the next several years, I wouldnít be at all surprised to see China build up a significant stockpile.

TER: What about the U.S. or Canada?

GT: The U.S. and Canada both have plans to build more nuclear plants, more for environmental reasons that anything else. But Iím not convinced that they will follow through with many of those planned reactors because, in my mind, this terrible recession will drag on for North America. Nothing cures your power demand requirements as quickly as a protracted recession.

So I donít see the U.S. and Canada being areas of great growth. I think you really have to look toward the developing countries such as India and China as the mainstay for demand.

TER: Will China still be building a stockpile if theyíre in recession? Or would we have to wait to see China come out of the recession to start stockpiling?

GT: I believe that, as with oil, theyíre not pausing at all due to their own slower growth. Theyíre carrying on with plans to stockpile metals, particularly metals they produce, actually, to support domestic industry, keep their own mines operating and lower the number of miners who are flung out of work domestically. They donít want riots and people protesting. A lot of Chinaís actions address the desire to maintain jobs.

For example, within China, state intervention supports molybdenum prices. Theyíre buying molybdenum. Theyíre buying copper. Theyíve been buying aluminum; theyíve been buying zinc, trying to keep prices a little bit higher on the one hand, to keep the miners in jobs, but on the other hand also creating strategic stockpiles. They view that as a win-win situation.

TER: So they are mining all these industrial metals that you just mentioned in China. Are they also importing to build the stockpiles or can they do that solely from domestic resources?

GT: The imports are increasing as the Chinese are paying a premium to the LME prices. Youíre seeing imports come into the country. With copper, for example, an arbitrage situation closed in the last week or two, but you could have been buying copper in London, putting it on a ship, and sending it over to China for an arbitrage profit.

TER: That swings both ways. You have to be on the right side of the trade. Quadra Mining Ltd. (TSX:QUA) just had to write a big refund check because by the time the copper reached its destination, the price had dropped dramatically.

GT: Yes, you have to be on the right side of the trade or else mitigate the risk by buying puts or entering into fixed-price contracts. If you donít mitigate the risk, you may get caught.

TER: But back to uranium, currently weíre seeing this spread between spot and the term price that a utility would pay. Spot is low because of the hedge fund selling, but you think thatís drying up. So where do you see the spot price and term price ending this year? What direction? What magnitude? And what are you looking at for 2010?

GT: For this year I expect the term price to drift down to $65 per pound or thereabouts, but the spot price to move upwards and end the year very close to the term price. So right about $65 by the end of the year. And then going into 2010, Iím looking at $70, then $80 the year after that.

I think prices will move back up to $100 per pound over the next five years. Come 2013, the agreement to dismantle nuclear weapons expires.

TER: Thatís between Russia and the U.S?

GT: Correct. Itís called the HEU Agreement, the Highly Enriched Uranium Agreement, and when that expires, it will leave a 30-million-pound gap in supply. A nuclear power generator thatís just spent several billion dollars adding another couple of reactors will want to be sure of a uranium supply, so itís in their interest to foster new supply before 2013.

TER: A couple of weeks ago, a Japanese consortium and Mega Uranium Ltd. (TSX:MGA) announced an agreement to joint venture on Megaís Lake Maitland project in Australia. Will we see more deals like that?

GT: Yes. Another one is Korea Resources.

TER: So might we see sovereign governments themselves, particularly the ones weíve talked about, buying uranium? Would you expect an increase in countries actually buying in this sector of the market?

GT: Yes, and I think itís a wise thing for them to do. If they canít rely on their own corporations to ensure supply, theyíll probably step in.

Most countries, though, leave it up to the private corporations to ensure supply. For example, the Ontario governmentís unlikely to intervene to ensure that Bruce Power, which is a private partnership, has supply. The partnership owns the power station; itís up to them to make sure they have the fuel necessary to run it.

TER: Is enough mining underway currently to fill that 30 million pound supply gap? Or will there be a shortfall of supply for a certain number of years?

GT: Right now it looks like thereíll be quite a shortfall. Cameco Corporationís (TSX:CCO) Cigar Lake was the big hope for a lot of power stations or utilities. That mine, though, has been beset by flooding and now I doubt it will be in production by 2013. In fact, it may be even 2015. In my models, Iíve got it in 2015, but youíre really sucking on your thumb there, because it could take longer to seal those leaks. It will be far out. Itís hard to say at the moment because theyíre still trying to plug the fractures from which the water is inflowing.

TER: Or is it possible that they canít seal them?

GT: Theyíve been trying. Itís a very difficult situation. Theyíre in waterlogged sandstone and itís very difficult to stop these leaks. Even if they were to stop the leaks tomorrow and pump it dry, it probably would still be 2012 before the first uranium would come out anyway.

TER: Would any another potential property be able to come into production before 2013 to yield the Cigar Lake amount of uranium?

GT: Not really. The forecast production rate for Cigar Lake is 18 million pounds of uranium per annum, so that would have taken away a little more than half the gap. The last frontier for a major jump in supply is Australia. We really need Australian governments at the state level to open up their mining permits to allow more uranium mines.

TER: Wasnít that voted in last year?

GT: The federal government has voted it in, but some of the states are taking their time. So the federal government wants it; they basically said weíre in favor, but itís really up to the states.

TER: Isnít a vote in Queensland scheduled soon?

GT: Yes, there is. I spoke with Paladin Resources Ltd. (TSX:PDN) recentlyótheyíre over there in Australiaóand they expect both the Liberal Party and Labor Party are in favor of it. Itís a question of time. Even with permission to go ahead and develop uranium deposits, though, itís still very tight to get something in by 2011.

TER: Given this picture youíre painting of this massive shortfall in supply, itís somewhat surprising to hear that you arenít projecting the price to go up more rapidly as we move toward 2013. Energy is strategic to most countries and many of them, such as France, China and India use a lot of nuclear power.

GT: Itís quite a jump. Iíve got it going up to $100 per pound. It could go a lot further if thereís no visibility of filling that hole in supply. But right now I think $100 a pound is fine.

TER: What are some stocks that you like in the uranium space?

GT: I like Paladin Resources, itís a growth company. Theyíre going to be building production up quite rapidly over the next several years. They really just started, and this year they should do about 2.9 million pounds of uranium production. It should be 6.8 million pounds by 2011 and about 14 million pounds by 2014. Itís one of those Australian deposits that I believe will be coming on stream.

TER: Because the government will say itís all right to add another mine.

GT: Yes, Iím sure they will.

TER: So youíre counting on that.

GT: Thereís nothing like a worldwide downturn to open up governmentsí minds. I like the growth of that company. Another interesting one thatís a lower technical risk is Uranium Participation Corp. (TSX:U), which just holds physical uranium. So you donít have any of the technical risk.

TER: So thatís really a pure play. How would that differ from buying an ETF of a particular commodity?

GT: Itís not particularly different. You get the straight increase in NAV when the price goes up. What is slightly different from an ETF is it tends to trade at multiples on discounts to NAV depending on sentiment. For example, when uranium was in the bull market, Uranium Participation Corp. was trading at a price-to-NAV ratio of 1.45 times, so a 45% premium to its NAV. Right now itís trading at about a 12% discount.

TER: Isnít there another nuclear holding company traded on the AIM?

GT: Itís called Nufcor Uranium Ltd. (TSX:NU). They recently listed on the Toronto Stock Exchange as well. Thereís no liquidity in the TSX though, so if you want to buy it, you have to buy it on the AIM. Nufcor has higher expenses than Uranium Participation Corp. They do lease out the uranium to undisclosed counterparties, too, so itís a higher risk exposure because you donít know what the counterparty risk is.

TER: Thatís probably why it sells at a much larger discount.

GT: Probably.

TER: Any other uranium companies?

GT: Cameco, of course. Then the ones I mentioned are about the only ones Iím looking at. The others, I find, are a bit higher risk.

TER: Any comments on Cameco aside from its Cigar Lake problems?

GT: Cameco probably serves as a good vehicle for exposure to the uranium market because there are so few large liquid names out there. I have a hold on Cameco just now. Theyíve got a lot of cash flow from third-party sales, so production isnít keeping up with their sales growth. I find the accounting to be very complicated with Cameco as well.

TER: Do you have a comment to give us on U3O8 Corp. (TSX.V:UWE)?

GT: It is one of the better quality juniors. I know management; Iíve met them several times. Iím not sure how much cash they have now, but you could describe them as a cash-rich junior with good management.

TER: In todayís market, thatís what you want. Gotta have the cash; otherwise, thatís a problem. And then you need the management who can figure out what to do with it, ride the storm. Where are U3O8 Holdingsí assets?

GT: Guyana. They have a small resource, 5.8 million pounds, already delineated. Thatís the hardest bit, you know, getting the first resource. Itís easier from then on to keep drilling it and build it out.

TER: Are they currently mining some of this resource?

GT: No, just exploration at this point.

TER: Another name on your list is Fronteer Development Group (TSX:FRG) (NYSE.A:FRG); their recent Ďbring back home the babyí deal with Aurora gives them more than 90% ownership.

GT: Yes, for cash, really.

TER: (Fronteer CEO) Mark OíDea really has done a shrewd deal there.

GT: Thatís right. Heís brought it back in, basically, paying not much more than cash. For the time being, though, Fronteer is really more of a gold company because theyíre not going to be doing anything with the uranium asset so long as the mining moratorium is in play.

TER: But arenít there other things they can work? They could be getting ready to mine once that moratorium is over.

GT: Yes, you can spend a little bit of money getting ready, doing some metallurgical test work and doing some background for the environmental impact statement. But if I were Fronteeróand I think this is what they are doingóI would not be spending much money there at all to send the message that you canít treat private companies like that and expect them to continue to employ people.

TER: Is it a foregone conclusion that the moratorium will be lifted?

GT: Itís still an open issue, but I think it will be lifted. Itís more a case of the Inuit not being ready to accept an environmental impact statement and to manage a process like that. They have neither the skill set nor the people.

TER: But they realize they have potential jobs and royalties and taxes and so on. Theyíre basically a new nation within a nation.

GT: Iím sure theyíre well aware of that and it was a very close vote not to let the mining go ahead, so I think three years from now theyíll be ready for that deposit to proceed.

TER: You have Fronteer as a speculative buy?

GT: Yes.

TER: You also have Tournigan Energy Ltd. (TSX.V:TVC) (FSE:TGP) as a speculative buy?

GT: Yes. They have a deposit over in Slovakia; basically a very good deposit with about 40 million pounds of high-grade uranium at 0.5%. The problem there is that it is, I believe, followed by environmentalists right now. I think theyíll probably get permission, but itís going to be a long haul. If youíre patient, itís one with a lot of value.

TER: Gabriel Resources had quite a time in Romania trying to get its big gold and silver deposit, Rosia Montana, permitted. Once you make the big discovery and all, thatís when the real work begins.

GT: Thatís right. Particularly in Europe, itís so easy for NGOs to travel from London to any European city. That makes it a lot easier to protest. You donít see many protests in the Congo.

A research analyst specializing in the mining sector at Blackmont Capital , George Topping has more than 20 years of experience in the mining industry as an analyst in brokerage firms and in management positions for South African mining companies. Early in his career, George gained valuable production experience with the Gencor Group, a major South African mining company with assets in North America, South America and Turkey as well as Ghana and South Africa. He moved on to develop financial analysis skills in Gold Fieldsí Mineral Economics Department, where he conducted due diligence on potential acquisition targets. George switched to the sell-side of the investment industry in 1995 as an analyst for Irish & Menell Rosenberg in South Africa. He migrated to Canada two years later, where he has continued to pursue his career as a sell-side analyst in the base metals and minerals sector, most notably at Sprott Securities from 1999 to 2005. His coverage at Blackmont includes a mix of emerging and mid-cap companies in the base metals sector, each with varying degrees of exposure to copper, zinc, uranium and molybdenum.

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