Sprott Physical Uranium Trust & Yellow Cake: Buy Discounted Uranium

Uranerz im Bergwerk, Konzept der mineralischen Strahlung, radioaktive Energie

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The Uranium Bull Case

The Uranium industry emerged from a decade-long bear market and structural oversupply from 2007 to 2017. The +10-year bear market resulted in systemic underinvestment. The enormous overhang of U3O8 reserves, particularly produced by the Kazaks, disappeared, and prices started to rise again.

During the ongoing Bull Market, Uranium prices tripled from $20 per pound in 2017 to $65 in April 2022. However, U3O8 prices had a harsh setback in recent months. The Bull Market is in a matured state, but I believe there is still significant upside left. Currently, Uranium trades at $48 per pound, but the fundamentals were never stronger.

Uranium price

Uranium price (tradingeconomics.com)

Long-Term Picture: Demand > Supply

Demand is set to outstrip supply for a prolonged period. The supply side hasn’t seen significant investments for over 10 years. Because of the low Uranium prices, there was no incentive to explore and develop new mining facilities. In 2016, major mines started to shut down (e.g. McArthur River, Rabbit Lake). Commodity and energy prices during the last 10 years were suppressed because of the massive overhang of supply. Most notably, the US shale revolution was responsible for the final collapse of energy prices and thus energy investment. Low prices for oil products were substantially lowering the input costs of miners globally.

Additionally, political headwinds restrained further progress in Nuclear Energy. Fears about Nuclear Reactor meltdowns and the association with nuclear bombs influenced the public materially. Being against Nuclear Energy was an easy way for politicians to collect votes. In my home country Germany, for example, the rejection of Nuclear Energy was extraordinary.

From the viewpoint of the commodity cycle, things are changing. Rising commodity prices across the board are the result of the previous underinvestment. If prices rise enough, companies will invest again, and the resulting additional supply will reverse the current situation of elevated prices.

The best thing that policymakers can do in this environment is to encourage investments of commodity and energy producers. Unbureaucratic incentives for companies will speed up the recovery of the supply side to match the demand side. However, the West (especially Europe) is doing the opposite. The upturn of the commodity cycle will likely be prolonged because of additional taxes on “excess profits” and the further tightening of ESG regulation, no matter the circumstances. For example, the forward curve for Oil futures remains in heavy backwardation, discouraging companies from drilling.

Mines in 2021 supplied ~56.950 Tonnes of Uranium. Nuclear reactors in the world require ~74,000 Tonnes of Uranium per year. That is what the current supply and demand situation looks like:

World uranium production and reactor requirements

World uranium production and reactor requirements (World-nuclear.org)

It is important to note that several mines are restarting operations. However, companies seem hesitant to increase production. Cameco’s McArthur River is set to reopen in 2022 after sitting dormant for 3.5 years. However, production will take a while to ramp up, and the company assured to be restrictive with their mining volumes. Kazatomprom, the miner with the lowest cash costs per pound, also seems hesitant to increase production volumes. However, these dynamics have to be closely analyzed.

Deglobalization

Globalization during the 2010s resulted in no need for domestic Uranium production, as Uranium mining, conversion, and enrichment could easily be outsourced. Today, 90% of Uranium is consumed by countries with little to no domestic Uranium production. The US is still the largest importer of Uranium, with an annual consumption of ~50 million pounds (~22.680 Tonnes). However, in 2021, the US only produced 21.000 pounds of U3O8 domestically.

41% of all Uranium is produced in Kazakhstan by their partially state-owned company Kazatomprom (LSE:KAP). Kazatomprom has strong ties to Russia and their state-owned company Rosatom. Rosatom has a market share of 40% of global Uranium enrichment services, 26% of global conversion services, and 14% of global Uranium mining. If the West were to sanction Russia’s Uranium enrichment and conversion services, this would provide another catalyst for the Uranium price to increase. However, I believe such sanctions would damage the West more than Russia. Therefore, they are unlikely to happen unless the West is able to build up its own Uranium supply.

Regardless of potential government sanctions on Russian Uranium, many operators are already self-sanctioning their Uranium supplies. Strategic reserves are important for nuclear power operators because the reactors serve as baseload energy. Shortages of Uranium could be costly if reactors need to be turned off. This is why the operators usually lock in supply contracts for several years. With the current war in Ukraine, Western operators will likely close deals with companies outside of Russian influence, while Chinese operators will most likely strengthen their ties with Russia and Kazakhstan.

A period of deglobalization could drive prices higher, even without government intervention. However, government subsidies are likely on their way to the US. Recently, the US government pushed a $4.3 Billion legislation that will authorize the Department of Energy to establish a national strategic uranium reserve. It will also increase domestic uranium production, conversion, and enrichment to ensure existing US nuclear reactors have sufficient fuel to continue operating. Early signs of rising U3O8 prices are exploding prices of Uranium services. According to Cameco (CCJ), Uranium conversion services today have never been priced higher.

Public Opinion

With significant headwinds of the green transition in Western countries because of rising energy costs, the public opinion on nuclear energy recently took a U-turn. Governments are questioning their views on nuclear energy. The underlying rationale consists of the same arguments that proponents of nuclear energy always had. Wind energy and solar are intermittent and unstable. Therefore, they don’t provide any reliable baseload of energy. Coal and natural gas, on the other hand are reliable but emit CO2, and hydropower is limited to a specific landscape. Nuclear Energy is largely CO2-neutral, safe, and provides a reliable baseload that can be opportunistically supported by wind and solar. The only downside is the resulting nuclear waste, which is expensive to store but manageable and a lesser evil than the downsides of other energy sources.

Recently, the EU Commission recognized the importance of nuclear power in the ongoing “green revolution”. Japan is restarting some of its Nuclear Reactors after they experienced close to zero casualties related to radioactive radiation after the accident in Fukushima. This will reduce the reliance on USD-denominated energy imports of Japan and eases the inflationary USD/JPY pressure because of (silly) monetary policy during the last 10 years. In 2021, China has announced plans to build 150 new reactors until 2035. To put a perspective on that number: By the end of 2020, there were 442 operational nuclear reactors worldwide. Sadly, only Germany is sticking to their plan to phase out Nuclear Energy. In my view, a terrible mistake amidst the ongoing European Energy Crisis.

Global Nuclear Reactor Outlook

Global Nuclear Reactor Outlook (NexGen Investor Presentation)

Risks To The Uranium Bull Case

I would attribute almost no risk to the demand side, as I view the shift in the public opinion toward nuclear energy as healthy and sustainable. However, in the event of a nuclear meltdown, the sentiment will change again. This tail risk could result in governments trying to exit Nuclear Energy and pose a real threat to the bull market.

The supply side has several risks that have to be addressed. First of all, Kazatomprom, the biggest Uranium producer by far, has expressed its plans of keeping production stable to support the Uranium price. Kazatomprom reached 40% of the global Uranium production. However, they could increase their production further if they wanted to. The company is somewhat underfollowed, but investors need to keep their production updates in mind. The company has incredibly low break-even costs, around $20 per pound.

Secondly, the Uranium sector measured by market cap is relatively small and has a high beta. In the event of a market crash because of a global recession or credit crunch, prices of the stocks and funds in the Uranium sector are likely to be more volatile than the broad market, which results in more downside potential. Many of the sectors’ companies and funds are also dependent on additional investment inflows to continue their operations or to fulfill their purpose of accumulating U3O8.

Where To Invest? Companies Vs. Funds

Investors can participate in the Uranium market by investing in Uranium related companies. However, there are only two major (pure-play) Uranium producers listed on stock exchanges. The first is Cameco, the largest Canadian Uranium producer, and the second is Kazatomprom, the largest producer of Uranium in the world, based in Kazakhstan. Kazatomprom pays a sizeable dividend and trades at a significant discount because of poor (but improving) stock liquidity and the risks associated with being tied to Russia. Cameco trades at a significant premium because of its prime position for sales to US Nuclear reactor operators. The prospects of Kazatomprom depend on Chinese and Russian demand for Uranium, and the prospects of Cameco depend primarily on American demand.

Kazatomprom (blue) & Cameco (orange)

Kazatomprom (blue) & Cameco (orange) (www.tradingview.com/x/7hzaLr5z/)

Additionally, there are a few American companies that already produce Uranium domestically or aim to start production in the near future (Uranium Energy Corp. (UEC), Energy Fuels (UUUU), enCore Energy Corp. (OTCQB:ENCUF), Centrus (LEU), Ur-Energy (URG)). But without extraordinary insights about the prospects of their mining operations, I wouldn’t invest in these companies as uncertainties remain high and valuations seem somewhat lofty. The North Shore Global Uranium Mining ETF (URNM) seems like a good diversification tool if Investors want to have exposure to global Uranium miners.

I believe the best risk/reward in the Uranium sector remains having direct exposure to the price of U3O8. There are two ways to buy physical Uranium: The Sprott Physical Uranium Trust (OTCPK:SRUUF) and Yellow Cake plc (OTCPK:YLLXF).

The Sprott Physical Uranium Trust invests and holds substantially all of its assets in Uranium in the form of U3O8. Investors can buy and sell trust units with an at-the-market (ATM) program. If shares of SRUUF trade at a 1% premium to NAV, the trust can issue units to the market. The trust then buys pounds of Uranium with the proceeds, which increases the fund’s NAV and takes off physical pounds from the uranium market. The trust managed to increase the total pounds of U3O8 held from 18.3 million in July 2021 to 56.7 million in June 2022, adding pressure to the already tight market conditions.

Because of the recent market turmoil, SRUUF is trading at a significant 13% discount to NAV. I believe this represents a good buying opportunity.

NAV & share price of SRUUF

NAV (yellow) & share price (green) of SRUUF (sprott.com)

Yellow Cake, on the other hand, is an investment company that also serves as an investment vehicle that holds physical Uranium in the form of U3O8. Yellow Cake is able to purchase $100 Million of U3O8 directly from Kazatomprom per year, usually for a relatively cheap price. Currently, Yellow Cake holds 18,805,601 pounds of U3O8. If these pounds are valued at $47, then the current NAV per share is $4.83. Yellow Cake is trading at $3.91. Therefore, the discount to NAV is at a whopping 19%.

I believe the reason for the discounts to NAV of both investment vehicles is the strong correlation to the general market. In a liquidity drought, the correlation of all assets tends towards 1. When the market selloff due to tightening monetary policy and fears of a global recession is done Yellow Cake and the Sprott Physical Uranium Trust should see substantial inflows again. The discount to NAV should disappear. I believe both investment vehicles offer the best risk/reward in the Uranium sector because they have no exploration, development, or operating risk and are purely valued by their U3O8 holdings. I am bullish on the Uranium price with a time horizon of 2-3 years.

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