A Healthy Glow

The Daily Reckoning PRESENTS: Three large-scale factors have turned the tide in favor of nuclear energy: geopolitics, global warming and developing world growth. In the below essay, Justice Litle explores all of these factors – and more…

A HEALTHY GLOW

“The proposed reactors will be of an improved and simplified design, pre-approved, more amenable to maintenance and operation than the first-generation reactors designed before 1980… Some studies estimate that more than 1,000 additional [reactors] will be needed in the next half century.”
– Retired Los Alamos scientists William R. Stratton and Donald F. Peterson
“You don’t need a weatherman to know which way the wind blows.”

– Bob Dylan

Cigar Lake, in Canada’s Saskatchewan province, is home to one of the richest uranium ore bodies on the planet. At 232 million pounds of proven and probable reserves, the economic value of the find is nearly $14 billion by recent spot price.

Cigar Lake production was expected to save the day for hungry nuclear power utilities – 103 of which operate in the United States. The plan was to have 7-8 million pounds of production online by 2008, with as much as 18 million pounds a year not long after. Cigar Lake was expected to supply 50% of all new uranium production within five years.

Then the walls caved in. Literally.

Concrete-reinforced steel doors were in place to hold back the lake, but an underground rockfall caused the doors to give way. Water rushed in at 1,500 cubic meters an hour; in due time, the mine was flooded.

The flood is a costly setback for Cameco (CCJ: NYSE), 50% joint owner of the Cigar Lake mine, and a major headache for uranium buyers in general. Kevin Bambrough of Sprott Asset Management believes American utilities will be particularly squeezed.

“The delays… will create a sense of urgency for the next few years,” Bambrough said. “It’s almost the equivalent of the oil industry losing Saudi Arabia.”

Uranium prices are surveyed and quoted on a weekly basis by various industry watchers. The recent move from $56 to $60 a pound was “the largest weekly increase on record,” according to Eric Webb of Ux Consulting. Long-term forecasts of $75 and even $100 a pound now appear justified; uranium would have to trade above $111 a pound to break its inflation-adjusted highs from 1978.

This is more than just subterranean cave-in blues: The uranium spot price hasn’t seen a down month since 2001. For years now, uranium producers have met just 60% of total annual demand – the other 40% coming from government stockpiles and decommissioned nuclear warheads. This can go on for only so long.

The tightness of supply comes at a time of atomic resurgence. Three large-scale factors have turned the tide in favor of nuclear energy: geopolitics, global warming and developing world growth.

First, geopolitics: The unpleasant consequences of fossil fuel addiction splash across the headlines every week. Mahmoud Ahmadinejad predicts the collapse of Israel, the U.K. and the United States… Hugo Chavez vows to defeat “the most powerful empire on Earth”… Vladimir Putin waves off brutal assassinations while cranking up the Cold War rhetoric… and so on.

All this and more is fueled by an unquenchable thirst for oil and gas. Nuclear power may not offer a direct path to energy independence – we can’t put uranium rods in our gas tanks, as Peter Tertzakian observes – but it is a big step in the right direction. (And if hybrid car sales continue to skyrocket, drivers could conceivably “plug in” at night, when traditional electricity demand is low.)

Second, global warming: The debate rages on; many still agree with Sen. James Inhofe (R-Okla.), who called global warming the “greatest hoax ever perpetrated on the American people.” Yet political ideologies aside, mounting evidence is getting harder to ignore. While China, North America and Australia are endowed with huge deposits of thermal coal, the consequences of accelerated coal use could be dire. (Air pollution factors in too; filters in Lake Tahoe, your editor’s beloved backyard, are already clogging up with Chinese gunk.)

Whether the public accepts global warming or not, Western governments surely do. The United States was arguably the last holdout, and with Sen. Barbara Boxer (D-Calif.) succeeding Inhofe as chair of the Environment and Public Works Committee, that domino has clearly fallen. Politics aside, this is another feather in uranium’s cap: Regime change in Washington, combined with the urgent need to “do something” about global warming, works in favor of nuclear energy.

The Democrats would no doubt like to rely more on greener solutions, like solar and wind, but those industries are still too small to pack a meaningful wallop. The green technologies of tomorrow hold great promise, but they have not yet demonstrated an ability to perform at scale. Nuclear power has already demonstrated its safety, scalability and 90%-plus reliability, with next-gen technology like pebble bed reactors offering improved maintenance and safety to boot.

The final factor driving a nuclear renaissance is developing world growth. The historical correlation between energy use and economic growth is high; when rapid industrialization kicks in for a developing world country, the energy consumption path goes parabolic. Asia knows that relying on fossil fuels to drive the next stage is a mug’s game, for geopolitical, environmental and financial reasons. Besides, there will already be enough headaches as we try to fill up all those cars (hybrid diesels anyone?) and enough pollution to deal with aside from new power plants. Fossil fuel use is going to rise dramatically no matter what; nuclear power will help take an edge off that pain. Let a hundred reactors bloom.

So where will the uranium to fuel a nuclear resurgence come from? With government stockpiles covering 40% of present demand, the question looms large.

For one, Cameco is confident that Cigar Lake will eventually be up and running. The costs will be high, but that uranium is too valuable not to be accessed – and Cameco should recoup its recovery costs and more in the long run.

An important future source could be Australia, home to 38% of the world’s low-cost uranium reserves. Surprisingly, for a country so rich in the stuff, Australia does not operate a single nuclear power plant – yet. The “lucky country” still relies on coal for 80% of electricity needs. Yet a government report recommends adding nuclear to Australia’s energy mix to lower greenhouse gas emissions, and Prime Minister John Howard recently called the rise of nuclear power in Australia “inevitable.”

A commissioned study argues Australia could quadruple its export profits by enriching and fabricating uranium at home, rather than shipping it abroad unprocessed. Local environmentalists may protest against expanded uranium trade, but friendly pressure from the United States could win out… especially when combined with lucrative economic incentive.

Another country keen on nuclear power is Russia. Home to an estimated 15% of world uranium reserves, Russia could yet go from exporter to importer in the coming years. The official plan is to dramatically expand nuclear power’s share of the Russian energy mix, to 25% by 2020. Russian uranium production will have to grow approximately 433%, from 3,000 tons a year to 16,000 tons, if domestic supply is to do the job.

On the positive side, existing government stockpiles of uranium can act as a buffer against volatile demand. Construction costs make up the lion’s share of investment for a new plant, with ongoing fuel and maintenance costs relatively small in comparison; the hitch is that a steady supply of fuel – the uranium itself – should be locked up in advance, preferably via ironclad contracts. This puts a lot of power in the hands of financiers, who like to see a reasonably steady production stream before committing funds. The financiers are thus relieved to know that governments are on their side, with a willingness to act as swing supplier in the event of temporary shortages. The U.S. government in particular is doing all it can to get the nuclear resurgence jump-started, including making generous offers of “regulatory insurance” to utilities who get the ball rolling.

All in all, the pieces are in place. The rise of safe, clean nuclear power is in most everyone’s best interest… except the petrocrats who want to keep the world as addicted to fossil fuels as possible. Uranium producers could have some very good years ahead.

Regards,

Justice Litle
for The Daily Reckoning
January 3, 2007

Editor’s Note: Justice Litle is an editor of Outstanding Investments, ranked number one by Hulbert’s Financial Digest for total return performance over the past five years. 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).

It was the “Year of the Junk Bond,” says Forbes. Lenders lent to marginal enterprises as if they were the last borrowers on earth.

But wait – so did lenders lend to marginal homebuyers. Junk mortgages – where buyers borrow more money than they can pay back to buy houses they can’t really afford at prices that are higher than the houses are worth, promising to pay back the loan only when – and if – they can get around to it – also hit record numbers.

So many records were broken in 2006, we could barely keep up with them. Private equity was on a roll by year end – with twice as many deals as the year before…financed, of course, by record lending on the part of recordly reckless lenders with a record amount of loose change in their pockets.

Mergers and acquisitions, too, hit record levels. Corporate profits reached record levels. Real estate deals in New York City hit noteworthy records. And of course, so did derivatives. And the Dow itself, as everyone knows, was at record levels.

Everything was hot in 2006, not just Wall Street. January through June was the warmest first half of any year in the continental United States since records began in 1895. The average January-June temperature was 51.8 degrees Fahrenheit – 3.4 degrees above the 20th century average.

It was so hot that both Britney and the hedge funds forgot to put on their shorts. The former Mrs. Federline set a record for celebrity buffoonishness…but the hedge funds set a record too. The great guru, Joe Granville, once walked onto stage to give a speech and immediately dropped his pants. “This is just to show you the importance of shorts,” he told the audience. But in 2006, hedge funds forgot the lesson. They stopped hedging in order to attract more money. Everyone seems to think he can get rich by speculating…but you can’t get rich speculating on the down side while the bubble is still hitting new records. So, the hedge funds dropped their shorts and started speculating on the long side…along with every other addled gambler with a drink in his hand and a dollar in his pocket.

There were records set in politics too. It was the first time ever, so as we can recall, that a Vice President of the United States of America mistook a middle-aged hunter for a duck and blasted him with buckshot. And the Bush administration must have broken all records for spending money…as well as for overseas military misadventures. But who bothers to keep track?

Records are meant to be broken, but we didn’t realize that so many of them had to be broken in such a short period. Housing properties all over the world hit record levels. Even in places like Bombay, India, you can pay as much for an apartment as you would in New York. House prices in England rushed up 10%…even though they began the year already at extraordinarily high levels.

All over the world, stocks hit new highs…with the Chinese leading the way. Chinese stocks doubled in the last year, hitting – naturally – a new record. So did commodities. Tin reached a 17-year high by year-end. Corn is at a 10-year high. And uranium is near an all-time record high last month, closing at nearly twice the level at which it began the year.

Many consumer prices, too, reached record highs. Housing, of course. Gas prices rose nearly two cents over the past two weeks, to a record high of $3.02 per gallon of self-serve regular, a national survey reported Sunday. But health care, transportation (largely because of record oil prices), and education rose too!

But the record we find most intriguing is in the art market. Overall, the Mei-Moses art index rose a record 22%. In the summer, a Gustav Klimt sold for a record $135 million. No one had ever paid that much for a painting. And then, a few months later in the year, along came someone with more money to spend. He laid out $140 million for a Jackson Pollack.

And here, we have to sit down and compose ourselves, our pulse races so. The buyer chose to remain anonymous. What a shame. Anyone who would spend $140 million on a dreadful painting deserves notoriety. In fact, more than that…he deserves clinical study. That amount of money would produce about $7 million in income each year, if invested at 5%. What kind of person could get $7 million dollars worth of pleasure from looking at a Jackson Pollack painting each year? What kind of person would be willing to look at it at all? We need to know more. Is this person normal? Is he allowed out in public? Is he human? Obviously, he has a lot more money than we do. But if he is so rich, how come he’s not smart? Or are we the dumb ones?

If he cannot get $7 million in annual satisfaction from the painting, perhaps he can rent it out. Yes, dear reader, maybe you will have the opportunity to rent it. Let’s see, the daily rate should be something like $20,000. Surely you’d pay $20,000 to have an oeuvre of Jackson Pollack’s on your wall for 24 hours. Who wouldn’t?

Unless the owner can get a return of $7 million…he must be counting on something other than yield. He must be counting on capital gains! He must be counting on an even higher price…and an even greater record! He’s probably betting that there is an even greater fool.

And he may be right.

What is the source of all this record-breaking activity, you might ask? A “Wave of Liquidity,” says the Financial Times. Bank Credit Analyst, in Montreal, picked up the idea, predicting that the ‘wave of liquidity’ would continue in 2007. The Wall Street Journal, meanwhile, modified the idea slightly, referring to investors riding ‘rapids’ of cash.

Rapids, waves, swells, tsunamis…no matter what you call it, there is a huge amount of liquidity in the world. And at of the close of 2006, it was still pushing up asset prices and setting new records just about everywhere.

First, the news:

————–

Chuck Butler, reporting from the world currency trading desk in St. Louis…

“As far as 2007 is concerned… I see a continued weakening of the dollar, albeit not as pronounced as in 2003 and 2004… That is unless the Chinese pull a rabbit out of their hat!”

For the rest of this story, see today’s issue of The Daily Pfennig

————–

And now more predictions:

*** The big question is this: When will this ‘wave of liquidity’ finally begin to ebb? We don’t know, of course. It is not given to man to know his fate. So we have to make our guesses and take our chances.

And our guess now is that too many people are betting too heavily that this wave of liquidity will continue…and some that it is not temporary, but permanent. Whenever too many people crowd onto one side of a trade – like piling onto one end of a teeter-totter – we want to take the other side; it is almost sure to pay off.

So let us imagine what might happen from this contrarian perspective:

1. First, we could see major weaknesses – even crashes – in several areas. The dollar remains extremely vulnerable. More and more central banks have announced that they are moving away from it. The euro edges up. Sooner or later, a panic could set in…in which case, the dollar could fall 10%…20% or 30% in a matter of days. Will it happen? We don’t know, but dear readers are advised to hedge against it, just in case.

2. A severe downturn could also come in the stock market. Not likely, but very possible. At this point, stocks are doing well…but our guess is that corporate profits will stagnate in 2007…and then turn down. There is very little real upside left in this market – or so it appears to us. We would want to get out of it before the exits get too crowded.

3. Less dramatic, but more certain, should be the decline of the housing market, which has already thrown up a few records this past year: The National Association of Realtors said that the median price of a home sold in October was $221,000, the same as in September, but down 3.5% from October 2005. The previous record drop was a 2.1% decline in November 1990.

There were record numbers of foreclosures too. Nearly 90,000 homes entered foreclosure in June…17% above the previous year. “Housing Market In Free-Fall As Foreclosures Eclipse Record,” say the local papers in Denver. Foreclosures overtook the peak set during the oil industry collapse in 1988.

In the first part of this year, we are likely to hear that housing has stabilized. It will look that way for a while – as sellers become reluctant to take any more price cuts…and house seekers take advantage of what they see as a buying opportunity. This illusion may be aided by a cut in Fed rates later in the year – caused by general weakening or local panics.

Gradually though, the fundamentals of the market will take over. One trillion dollars worth of mortgages are reportedly going to be reset in the year ahead. Many homeowners won’t be able to afford the new payments. Foreclosures will rise. Many of the absurd mortgages written in the last two years will go bad. Inventories of unsold houses will rise. Sellers will become more desperate. The whole thing will begin to sink.

Remember, the ‘wave of liquidity’ doesn’t help the marginal homeowner – except by making it easier for him to get himself deeper into debt. But once he and the lenders realize that he can’t continue servicing his debt, the credit dries up. Liquidity may still force up prices for Klimts and Picassos…and Chinese stocks…but it does little to help the poor householder who can’t pay his bills.

4.Gradually, too, problems at the bottom of the debt pyramid work their way up. Lenders will begin to realize that many of their credits aren’t worth what they thought they were. Then, the packaged, securitized, leveraged loan, debt Spam begins to lose its flavor. Look for a few major blow-ups in the financial industry – in derivatives and hedge funds particularly. Amaranth was not the end of the story, but just a prelude. Hedge funds will wish they had not forgotten to hedge.

5. The hedge fund industry itself is due for a correction. There are said to be about 8,000 funds in operation. Over the next two or three years, that number should be cut down to less than half that number. That is what happened to the mutual fund industry, following the bear market downturn after 1968. It will surely happen in hedge funds too.

Another development in the hedge fund industry is likely to be a reduction in charges. The industry is bound to become more competitive…and less profitable. Returns are already below those an investor could get by throwing darts at the stock pages. Our guess is that hedge fund managers have had their day of glory. It’s time for them to step back…and take in more normal earnings.

Most of the records for 2006 reflected record levels of hope, faith and recklessness. We don’t know what is ahead for 2007, but we warn readers that for every high there’s a record low. For every year of hope and expectation there’s a year of helplessness and desperation. And for every fool…there’s some wise guy waiting to take advantage of him.