There’s no denying that lithium is all the rage right now. The Australian Financial Review is talking about it, Motley Fool is talking about it, and Deutsche Bank is talking about it, so we decided to talk about it too.
The popularity of Lithium stocks is no surprise. Take a look at the share price of these Australian lithium miners over the last year:
Those gains are hard to ignore.
There are basically three main drivers of the surge in global demand for lithium:
- The world’s endless desire for new devices with bigger and better batteries (the majority using lithium-based batteries).
- Many car companies around the world are designing electric cars with the possibility that they will one day replace petrol, diesel and gas powered cars.
- The home energy revolution where homeowners are producing their own electricity with solar panels and storing it in batteries (rather than selling it back to the grid).
It all sounds very promising doesn’t it? I would not be one to argue against the prominence of portable devices, electric cars, and home energy storage in our lives in years to come. In fact, I very much hope they are (I would love a Tesla Model S). So why wouldn’t we be loading up on every lithium stock we can get our hands on? Should we be panicking that we’ve already missed the start of the boom?
Firstly, it is still unknown what the future demand for lithium will be like. Right now, demand is through the roof. Tesla Motors, the largest producer of electric cars in the world has stated that its battery producing gigafactory in Nevada could require the entire world’s supply of lithium-ion. And that’s only one company!
There are other uses for lithium too. According to the United States Geological Survey, in 2016 batteries only account for 35% of the world’s use of lithium. Ceramics and glass, lubricating greases, account for 32% and 9% respectively.
So yes, demand is high now, but what if a new type of battery is invented that is better than lithium batteries. One Australian Company called Redflow (ASX:RFX) has designed a zinc-bromine flow battery to store power from solar panels. So there are other viable options, and who knows what the innovators of the world will come up with.
What if all of these new lithium mining companies oversupply the market and cause prices to fall? Though this does seem unlikely in the next few years thanks to Tesla, eventually this may become a reality.
The rush for lithium is also remarkably reminiscent of the uranium bubble in the mid 2000s. In 2005 the world was gearing up for the end of fossil fuels and the start of the nuclear power age. Many countries were building nuclear power plants, and hundreds of companies sprung up to meet the demand. Uranium prices went from around US$20 per pound in 2005 to a peak of US$135 per pound in 2007.
The interesting difference between uranium and lithium is that the spark that really ignited the uranium bubble was the collapse of the largest undeveloped high-grade uranium deposit at the Cigar Lake Mine in Canada – a shortage of supply. In the case of lithium, the same spark could be Tesla’s announcement that they are ramping up production of their electric cars to 500,000 by 2018 – a huge increase in demand.
In 2008 the global financial crisis began, and asset prices for nearly everything – including uranium – began to tumble, popping the so-called bubble. So while everything now seems to point to a lithium-lined future, we would rather be cautious not to repeat the mistakes of the past.
So back to our original question, should we be loading up on lithium stocks? Are we missing out?
At Farnam we generally steer clear of companies that can’t set their own prices for the goods they sell: companies whose profitability depends on the market price of a commodity.
We also only look for companies who have a proven track record of earnings and earnings growth – something that these mining stocks do not have.
Lastly, we also look for companies whose number of shares issued remain constant or decrease over time, as this reflects good capital management and profitability.
Because these lithium mining companies are very capital intensive, they require a high level of cash to pay for equipment, exploration and production costs when earnings may not flow for a number of years. This means that when they run out of money, they need to issue new stock to the market to raise more money, which dilutes current shareholders’ interest in the company.
The growth in share price of these companies has primarily come from punters hoping to win the lottery when these companies do strike lithium or starting producing and selling it. The people buying now are buying on market sentiment and assumed demand for lithium, expecting that the demand for lithium shares will also increase significantly.
Does it remind anyone else of the time when you could add .com to a company name and see the share price explode?
So even though right now there seems to be a great opportunity to make some money in the lithium sector, we will happily sit this one out and watch from the sidelines.
One final note. In the time it took between writing and publishing this article, there was a development for one of the above companies. Dakota Mining released an announcement that was not taken as positive by the market and was slashed 47% to $0.14. This shows just how volatile the sector can be when stock is traded on lofty forecasts and expectations.
To read about other factors Farnam considers when analysing companies, click here.
This document has been prepared by Farnam Investment Management Pty Ltd (Farnam) ABN 15 149 971 808 AFS Licence 430574. While every care has been taken in the preparation of this document it does not contain any recommendations to buy or sell any particular stock(s) noted. Farnam makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation and needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.