A Turning Tide

Utter the words "nuclear power," and people automatically think of the Three Mile Island and Chernobyl disasters. However, what the majority is starting to realize is due to technological advances and much-improved safety measures (among other factors) there is a nuclear renaissance happening. Justice Litle explores…

Similar to the commodity bull market, the uranium story is not brand-new. The price of yellowcake has more than doubled in the past two years, from $10.75 per pound circa early 2003 to around $25 as of this writing. Also similar to the commodity bull, uranium has barely scratched the surface in terms of upside. Outstanding Investments has booked major gains from uranium in the past; with recent weakness in the sector, it’s time to take another look.

With the volatile action and hefty upside seen earlier this year, uranium stocks have drawn comparison to the dot-com stocks of old. Because the universe of uranium stocks is quite small, investors have piled into the same clutch of names, driving prices up sharply. In recent months, the bloom has come off the rose, prompting momentum investors and short-term traders to head for the exits. This weakness gives us a chance to take a fresh look at uranium and assess the long-term prospects for nuclear energy.

Uranium Gains: Punctuated Equilibrium

Scientists Stephen Jay Gould and Niles Eldridge proposed the theory of punctuated equilibrium, which suggests that evolution is characterized by long periods of dormancy (equilibrium), occasionally interrupted (punctuated) by short, sharp shocks that create rapid change.

The history of uranium – and the evolution of its uses – would certainly fit the punctuated-equilibrium model. German chemist Martin Klaproth discovered uranium in 1789, naming it after the planet Uranus (which had been discovered in the same decade). Nothing much happened for almost a century after that; uranium’s radioactive properties went unnoticed until 1896. Forty-two more years down the road, in 1938, Otto Hahn and Fritz Strassman discovered nuclear fission in Berlin. The atom-smashing race was on.

On the morning of August 6, 1945, Little Boy exploded over Hiroshima – the first nuclear weapon wielded in war. Fat Man followed three days later, devastating Nagasaki with a force equivalent to 20 kilotons – more than 2 million pounds – of TNT. Little Boy and Fat Man killed more than 130,000 people instantly, with thousands more dying a slow death from radiation poisoning. A century and a half after its initial discovery, uranium rocked the world with deadly force.

After World War II, the newly created U.S. Atomic Energy Commission sought to put nuclear energy to peaceful use. After multiple setbacks and technical failures, the first privately funded nuclear power plant came on line in Illinois in 1959 (though the buying and selling of uranium was still strictly the province of the U.S. government; this law was lifted in 1968).

In the 1970s, with the OPEC-instigated energy crisis in full swing, nuclear power looked more attractive than ever. The Three Mile Island reactor at Harrisburg, Pa., opened for business in 1978. John F. O’Leary, President Carter’s deputy secretary of energy, offered warm words of praise: "Nuclear power is a bright and shining option for this country." O’Leary was dead wrong… or perhaps just two or three decades early.

The tide turned against nuclear power in 1979. Celebrity Jane Fonda appeared in The China Syndrome – a Hollywood movie portraying the risk of reactor meltdown – with perfect timing to devastate the nuclear power industry. The movie was released a scant two weeks before a combination of equipment failure and human error at Three Mile Island led to the worst nuclear accident in U.S. history. Fonda, eager to milk the spotlight for all it was worth, went on a cross-country protest tour with her activist husband. Nuclear stocks got hammered.

Seven years later, in 1986, a far worse accident occurred at the Chernobyl nuclear power plant in Ukraine. Hundreds of thousands were killed, sickened by radiation or forced to permanently relocate. After this mega disaster, the nuclear power option became politically radioactive in the United States. Plans for hundreds of new plants were stopped dead in their tracks. Plants under current construction were decommissioned by regulators, at the cost of billions to utilities (and ultimately, taxpayers).

With nuclear power a political pariah and all new construction mothballed, demand for uranium took a beating. After the fall of the Soviet Union, Russia added to the glut by extracting enriched uranium from shelved bombs and diluting it to reactor grade, dumping supply on the market. The Clinton administration then depressed uranium prices further by releasing tons of surplus highly enriched uranium for conversion to reactor fuel to be sold via a privatized government entity.

Uranium Gains: The Tide Has Turned

Like most of what originates in Hollywood, the political aversion to nuclear power was always more sound than substance. Nuclear energy never really left the scene; it just avoided the spotlight for a long while. Today, nuclear power accounts for approximately 16% of total electricity generation worldwide. The United States has more than 100 nuclear reactors in 31 states. India has 14; South Korea; 19; and China, just nine -for now.

As you might imagine, uranium prices have seen a wild ride. In the late 1970s, before the public relations disasters of Three Mile Island and Chernobyl, yellowcake ran to $50 a pound on current and anticipated demand. After Chernobyl and the close of the Cold War, a supply glut relentlessly hammered prices to an all-time low near $7 per pound in December 2000. As mentioned earlier, we are near $25 per pound as of this writing and slated to go higher. Mining guru Doug Casey expects uranium to hit $100 – quadruple current prices – before all is said and done.

The tide has turned, for multiple reasons.

For well over a decade, the world has been consuming more uranium than mines have produced. Nuclear utilities are estimated to consume 170 million pounds of uranium per year, with only 50 million pounds of annual production in place. This was made possible through the massive supply overhang of past decades, born of reasons already mentioned.

In the ’80s and ’90s, supplies of uranium grew as demand receded. Now, we have the opposite situation: Demand is rising as supplies are dwindling.

As expected, appetites are most voracious in the developing countries. China and India alone have plans to build more than 40 new nuclear power plants in the next 15 years. South Korea and Mexico could take the tally of new plants over 50… enough new capacity to easily triple nuclear demand by 2020.

But that’s not all. The United States and Britain are re-examining the nuclear option as well. The Financial Times expects U.K. Prime Minister Tony Blair to endorse "a new generation of nuclear power stations" not long after the election. He will draw on a special report analyzing Britain’s energy needs that is almost certain to recommend the nuclear option. Meanwhile, in the United States, the Bush administration has rejected a moratorium proposal from the International Atomic Energy Agency. The reason behind the rejection? A desire to allow near-term civilian activity in the nuclear power sector.

The change of heart that has revived nuclear power can be boiled down to three areas: environmental concerns, energy demand and technological safeguards.

In spite of the environmental problems associated with the disposal of radioactive waste, the environment is a key factor in nuclear energy’s return to prominence. Two of the world’s most pressing environmental problems – global warming and air pollution – are attributed to our zealous use of fossil fuels. Nuclear energy is a viable alternative, and the disposal of radioactive waste is small potatoes in comparison to pollution issues. (As MIT’s Technology Review has noted, we could easily lock up our waste for generations and leave the disposal problem to a more technologically advanced society. Climate change and fossil fuel pollution, however, are here and now… and getting worse.)

Uranium Gains: The Virtues of Going Nuclear

Whether or not one sees global warming as a genuine problem, those environmentalists who do see it as a critical issue are forced to consider the virtues of going nuclear. In Britain, Tony Blair’s budding enthusiasm for nuclear energy is deeply rooted in a desire to mitigate the impact of climate change. In China, the issues of water and air pollution are key drivers. With pollutants in China as high as they are now, future levels will simply be intolerable. China has no choice but to look for alternatives in an effort to preserve what little quality of air and water it has left.

Rising energy demand is another key to the nuclear renaissance. As global demand for energy increases – and with "peak oil" just around the corner by some estimates – alternative energy sources need to be brought on line as soon as possible. Given the instability of oil-producing countries, steadily rising demand from developing countries and marginal slack in the system, secure energy sources have become a matter of national security for virtually all oil-importing countries. On the other side of Hubbert’s Peak, an investment in expanded nuclear power production offers insurance against supply shock. As a bonus, nuclear energy is seen as a potentially optimal route for mass production of hydrogen, required to run the next generation of "clean cars" built around fuel-cell technology.

The final pillar of nuclear energy’s return is technological advancement and vastly improved safety standards. China and South Africa are currently in competition to build the world’s first fully operational pebble bed reactor. The pebble bed design is both safer and less expensive than the monstrous pressurized-water reactors built in the past, relying on spheres rather than traditional fuel rods. The Economist explains:

"Eskom’s PBMR [pebble bed modular reactor], by contrast, is fueled by several hundred thousand tennis-ball sized spheres, known as pebbles, each of which contains thousands of tiny "kernels" the size of poppy seeds. Each kernel is a blob of uranium coated with high-density carbon. This coating is designed so that even if all the reactor’s coolant (helium gas, not water) leaked out, the uranium in the pebbles could not melt and release radiation into the environment."

China’s pebble bed prototype will differ from South Africa’s in small points of detail, but conceptually, they are similar. There are still technical hurdles to overcome, but Beijing’s dire need for energy alternatives is such that it is willing to foot the bill and bear the cost of experimenting. Successful implementation of pebble bed technology – and other technological improvements – will only improve the math for rich countries looking to expand the nuclear option. Meanwhile, environmentalists realize that they now have to engage in constructive dialogue or risk being ignored. Letting an energy crisis unfold without action is not an option, and so the green forces, who would normally oppose nuclear power by knee-jerk reflex, are forced to the table.

Regards,

Justice Litle
for The Daily Reckoning

June 16, 2005

P.S. There’s a new kind of nuclear power plant technology just around the corner that could make even $1,000-a-pound uranium cost just 0.03 cents per kilowatt hour. That’s like getting a gallon of gasoline for half a cent. China’s demand alone should double uranium prices over the next two years…and triple demand for nuclear power by 2020.

Justice Litle is an editor of Outstanding Investments. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall)

A report in yesterday’s Financial Times tells us that Japan is considering radical action to get its economy and its people moving. A proposal is on the table to cut working hours – to encourage young families to have more children.

We do not like to criticize, but we notice some problems with the concept. First, it is not going to take a couple very long to conceive a child. It can normally be accomplished during regular leisure time, on lunch breaks, or even on a holiday. Even if a man worked 10 or 12 hours a day, he’d still have at least another 12 hours to get the job done. Maybe we’re missing something, but if he couldn’t get around to it in 12 hours, we doubt that giving him another 15 minutes is going to make that much difference.

The other weak point we notice is that the program would be confined to government employees. There’s the real rub. The last thing a society needs is to encourage bureaucrats to replicate. There are far too many of them already.

This little news item set us to thinking about the way almost all policy initiatives are flawed, mistaken or frauds.

Here in Baltimore the talk is real estate, real estate, real estate. Everyone wants real estate. We’re only a few miles from the hottest market in the nation – Washington, D.C. There is a photo in the latest issue of TIME showing what a half-million dollars will buy you in Washington. It is a brick, two-story 1,900 square ft. row house with a plain front porch that looks like it was designed by Stalin’s plumber. The thing is relentlessly charm-free. The photo shows not the slightest hint of grace or beauty. No moldings. No shutters. The roof is flat. The porch columns are square. And the windows are lopsided. Who would want to live in such a place – even if it were free? Only someone who cares more for money than for style. Properties in the area rose 22% in price last year. If the buyer paid 20% in down payment he stands to double his money in one year – if the bubble keeps expanding at the present rate.

We looked at a building for sale near us in the heart of Baltimore. We own the one next door to it…for which we paid about $400,000. But our building was in good shape. The one we saw yesterday is a dump. Much of it would have to be torn down. The asking price: $2 million.

"We offered $700,000," explained a colleague.

"Did they take it?"

"No, they laughed."

It’s "America’s House Party," says TIME. What is amazing is that people are not even more "gaga" than they seem. If you can make $100,000 a year – doubling your money – buying ugly houses in the nation’s capitol, why not buy two of them?

Real incomes in America are flat or falling. GM lays off well-paid workers. Many of them end up as badly paid workers at Wal-Mart or some other retail outlet. A few go into home speculation. In a macro-economic sense, they are replacing real wages with phony ones. GM makes money by producing things that people wanted, and selling them at a profit. Whatever money you make by speculating in houses is money that must come from some fool who is even more benighted that you are. You buy the dumpy house for $500,000. You don’t make any money unless someone else comes up with more money to take it off your hands. You make money. The finance company makes money. The real estate agent makes money. The guys who put in your granite countertop make money. But, apart from the new granite countertop, not one bit of real wealth has been created.

You see, dear reader, it was Alan Greenspan’s policy initiative that created the present real estate fandango. He sent out the invitations. He ordered the drinks and chips. He lined up the band.

But who’s picking up the tab?

Ah…there’s the swindle. The Fed chairman is leaving office next January. Whether he leaves before the party is over or not, we don’t know. But we are sure he will leave the bill behind. It is likely to be a large one.

More news, from our team at The Rude Awakening…

————–

Eric Fry, reporting from Manhattan:

"Most of us are sick and tired or reading about the housing bubble, which is why your New York editor has decided to devote ONLY two of this week’s columns to the topic."

————–

Bill Bonner, with various opinions…

*** Everyone believes the euro is finished. But the euro rose yesterday, to over $1.21. Gold rose too – over $430. Both the euro and the dollar are sinking against gold.

*** "This is just like any other bubble," began a friend yesterday. "People have come to believe something that is not true. And they’re acting on it. They think property only goes up. So they’re paying outrageous prices, because they’re sure they can’t lose. Young couples buy bigger houses than they need – thinking they should get it now, before it becomes too expensive. Plus, they think they’re making money on it. And they can always take out the money – using an equity line of credit. And middle-aged couples are buying second homes and retirement homes. They’re not really ready for them, but they too believe the train is about to leave the station. They hop on board now…also sure that even if they change their retirement plans, their house in Florida or at the beach or in the mountains will be worth a lot more in the future than it is today.

"But what does the smart man do when there is a bubble? He sells it. You should tell your readers to dump the homebuilding stocks. And dump the finance companies. And dump the Home Depot and all the companies that have made a lot of money on this bubble. Sell now. You might be early. But better early than late. And oh yes, sell any house you don’t expect to live in for the next 10 years. This is a bubble. Get out."

*** Patience is a virtue that is unknown to most investors. Look at the housing market – people are so set on the instant gratification of easy money, they are refusing to see the obvious: a huge bubble that threatens to burst at any time.

I mentioned this to our resident small-cap analyst, James Boric, when I ran into him this week in Baltimore.

"Patience is what separates Graham, Templeton, Wanger, Buffett, Wanger and all the investment greats from the average "investor", small-cap or otherwise, on Wall Street," James said, as we walked toward the Daily Reckoning’s office in Mt. Vernon.

"Problem is…most folks nowadays have no patience. For them buy-and-hold means months – not years. I don’t know even one legend of Wall Street who made their fortune that way.

"Graham held his companies for an average of two years. Buffett rarely ever sells. Templeton, in one of the most famous moves of all time, held onto a portfolio of small-cap stocks for four years between 1939 and 1943 and quadrupled his money. And famed fund manager Ralph Wanger averaged over 17% for 30 years by holding stocks between four and five years – on average.

"Most people aren’t even willing to hold for even two years to make a profit – and it’s just too bad."