Flakes are king in the graphite space, where large flake commands a substantial premium. But the path to production can be long and twisted, with many moving parts. Resource and tech investor Ron Struthers met up with The Critical Metals Report and walked us through the funhouse of graphite investment. Read on to find out which companies look good in every mirror.
The Critical Metals Report: Ron, as a resource and tech-focused investor, you were clued into the graphite investment thesis before Wall Street caught on. How did you approach the market?
Ron Struthers: I was fortunate in that I had been familiar for many years with a graphite deposit in Northern Ontario so I was aware of the mineral's uses. I first realized the extent of graphite's potential in late 2010 when prices started to firm up. However, the timing was not right until graphite prices took off, which happened when the market became aware of the mineral's high carbon purity and the fact that there is a lot more graphite in a lithium-ion battery than there is lithium. High carbon is also used to make graphene, which is finding its way into a lot of high-tech applications. In addition to the big demand for lithium batteries in electric cars, graphene is used in cellphones and other battery-operated tech equipment. That is when I started looking around for other good graphite deposits, and discovered it's a pretty small market.
TCMR: Of the companies in the graphite universe – which ranges from 12 to 40 companies – how many might succeed?
RS: Over the course of the next 10 years or more, there could be quite a few success stories. However, it takes a long time to get a new mine up and running and with such a small market, one or two new graphite mines could substantially alter the supply-and-demand picture. I would advise investors to stick to companies that can get a new mine up and running sooner rather than later. That would allow the first companies to lock in better prices before other producers increase supply, potentially causing prices to drop off.
TCMR: Gareth Hatch recently echoed your thinking when he cautioned TCMR readers to evaluate the supply-and-demand projections carefully. Will the expected growth in electric vehicles and green energy be enough to support the market?
RS: Yes, I think so. The markets graphite is used for are expanding significantly.
The electric car could be critical. Although we have not yet seen it in the US or Canada on a large scale, electric cars are really big in China, which is now the world's largest auto market. Some 50 to 100 companies are developing electric cars, electric bikes and electric golf carts. Again, it is such a small market that one or two new graphite mines could create a situation where supply gets ahead of demand for a while and prices come down.
TCMR: If prices come down, would that be a short-term correction while demand catches up to supply or is that an indication of a bubble?
RS: I do not think graphite is a bubble. Longer term, I think we will see much higher graphite prices, along with most commodity prices. I would interpret price drops as a correction.
TCMR: China supplies roughly 70% of the world's graphite. Would a slowdown in the Chinese economy mean less domestic consumption and as a result have an effect on export prices?
RS: China's gung-ho approach to electric cars could really boost demand no matter what happens to the economy. And its economy is still growing, although at 5-7% instead of in the double digits. China is also curtailing graphite exports, which might squeeze the market even more. In 2011, a number of Chinese state-owned enterprises were closed to preserve China's graphite resources. China also imposed a 20% export duty plus a 17% value added tax, and instituted export licensing to ensure more supply stays for China's domestic economy. This approach to graphite is similar to what it has done with other metals and commodities. China is curtailing exports out of concern for its own long-term supply.
TCMR: Large-flake graphite is more valuable than lead or zinc, which makes flake size a consideration in evaluating a company. Do you focus mainly on flake size, resource size, grade, management, offtake agreements or all of the above?
RS: All of the above are important, but flake size and grade are very important. Flake size is important because you get much higher prices for larger flake. A large-flake graphite mine can command a 50% higher price, maybe more. Today, large flake is fetching prices above $2,500 a ton; more than $1 a pound. You can compare that to the lead and zinc. Grade is always important, because grade will bring down the overall mining costs.
TCMR: A number of critical materials projects involve restarting production at a historic mine. Are those more or less viable than projects that are developing literally from the ground up?
RS: Whether it is an old or new mine may not be very important. Infrastructure affects costs and the permitting process, so it is more of a factor today. I will say that a number of the old mines mainly produced small-flake graphite. Graphite's high carbon content was not an issue when some of these older mines produced because it did not have intended uses in batteries and the electronic industry, as it does now. In the past, it was used mostly in steel, furnace brick, brake linings, lubricants and a range of other manufacturing applications. A mine that could have been very good in the past might not have much of the large-flake graphite that is in higher demand and comes with a premium now.
TCMR: Given those criteria, which companies do you think will succeed?
RS: Of those that I have been following, Focus Graphite Inc. (FMS:TSX.V) and Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX) are in the lead.
Focus Metals is high grade, which will give the company lower mining costs, even if some of the graphite is not large flake. Northern Graphite has a lot of large flake and high purity, so its product will command a much higher price.
In addition, Graphite One Resources Inc. (GPH:TSX.V) just released some new drill results that looked good. Its project is in Alaska. Interestingly, the US has no domestic graphite mines. Strategically, a graphite mine on US soil could be a good idea.
TCMR: How do you define large flake? Do Focus Metals, Northern Graphite and Graphite One all use the same definition?
RS: I consider large flake to be 80 mesh or larger, which is the industry standard. The majority, 75%, of Northern Graphite's product is large flake. In fact, 50% is extra-large and extra-extra-large—50 and 32 mesh respectively. That commands even higher prices.
Focus has around 50% large flake. Given that Focus' grade is 16%, even its small flake, which commands a lower price, will be very profitable.
It is a little early to tell with Graphite One. Although the company claims the deposit has a lot of large-flake graphite, more work needs to be done to confirm that.
Purity is also important. You have to have 94-97% carbon content regardless of size to get good pricing.
TCMR: Do Focus and Northern Graphite have that level of purity?
RS: According to Northern Graphite's prefeasibility metallurgy, its overall purity is 97% and up to 98% for the extra-large flake. Focus still has to do more drilling and metallurgy, but its initial metallurgy shows around 86% purity.
TCMR: A lot of graphite companies have offtake partnerships. Is that important, and do these three companies have partnerships in play?
RS: Partnerships are important because this is a small market. Unlike gold, there is no market-established price. Companies need offtake agreements with industrial users. Both Focus Metals and Northern Graphite have established some partnerships. Northern Graphite is at the feasibility stage, but I believe it needs an offtake agreement before it will be able to get mine financing.
It is just too early for Graphite One; it needs to do more exploration and drilling first.
TCMR: Do you have target prices on Northern and Focus?
RS: I don't have specific target prices, but I think they can get back up to their old highs, and even challenge those prices when the market turns. Focus is priced around $46 million (M) in value if you take away its cash, and Northern Graphite around $36M. Both are still pretty small market caps. The graphite stocks held up for quite a while, but all have come back down to where they started. I think we could see a substantial rally.
TCMR: Will they grow in the same way an industrial metal would grow, based on the economy, as opposed to gold, which can be countercyclical to the economy?
RS: I think graphite is definitely more affected by the economy. But as long as the electric car market keeps growing, the broader economy will not matter as much.
In fact, graphite could be countercyclical as well. For example, rising energy prices are favorable for the electric car and the high-tech industry will continue with strong growth. Tech gadgets keep getting more powerful, so they require more battery power.
TCMR: What will be the hot material investors will want in 2013?
RS: I think the hot materials will be gold, silver and oil. Both metals are way down and have been consolidating for quite some time. Every time we have seen this consolidation pattern in the past 10 years, an explosion in price has followed. We are 18 months into this consolidation phase, so I think gold and silver prices are ready to take off.
As for oil, on the supply side it is getting harder to keep up with demand. We are drilling deeper, in remote areas, many of them offshore, in an effort to keep up with demand and the large, established oil fields are in decline. Add to that the likelihood of more trouble in the Middle East, and I think oil could surprise people in 2013.
TCMR: What about other energy plays: natural gas, lithium or uranium?
RS: There is still too much supply in natural gas. Granted, the drill rig count is coming down and the supply growth is leveling off in the shales. However, the in-ground storage supply in the U.S. remains above the five-year average – ample even with a hot summer. Unless we get a heck of a cold snap this winter, I think natural gas is still another year or so away before it will be ready to rally substantially.
Lithium's potential is also based on its use in batteries for electric cars, so I think lithium has good growth ahead of it.
For uranium, I think you need to look out longer term. Despite the big scare in Japan, there is not a lot of choice: Countries need electrical generation and nuclear power plants are the way to supply it in many cases. Japan will restart some of its reactors and China, Korea and Russia have a lot of nuclear plants in the planning stage. Russia's deal to supply material from old weapons to the US uranium market expires at the end of 2013. I think that in two to three years, demand will have built up enough that it will be pushing on the supply side of the uranium market again. I expect to see uranium rally at that time.
TCMR: Ron, thanks for your time and your insights.
Ron Struthers, editor of Struthers' Resource Stock Report, retired at an early age from IBM, where he spent many years in customer service and as a systems, business and inventory analyst. He began the Struthers' Resource/Tech Stock Report almost 20 years ago and now has roughly 450 subscribers. Over the previous 10 years, Ron's top 82 stocks averaged a gain of 935%. Ron focuses on mining, oil and gas and one to three tech stocks a year. He hunts for stocks that are not yet discovered and gets in before the crowd. Most of these are companies on the verge of new mineral discoveries, moving to producer status or simply on an accelerating growth path. Coverage includes senior and junior companies with ample trading liquidity. Ron's a long-term investor, picking major trends and sticking with them.Disclosure:1) JT Long of The Critical Metals Report conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: None. 2) The following companies mentioned in the interview are sponsors of The Critical Metals Report: Northern Graphite Corporation. 3) Ron Struthers: I personally and/or my family own shares of the following companies mentioned in this interview: Focus Metals Inc. and Northern Graphite Corporation. I personally and/or my family am paid by the following companies mentioned in this interview: None. Streetwise - The Gold Report is Copyright © 2012 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. The Gold Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report. From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported. Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734. Participating companies provide the logos used in The Gold Report. These logos are trademarks and are the property of the individual companies. 101 Second St., Suite 110Petaluma, CA 94952 Tel.: (707) 981-8999Fax: (707) 981-8998Email: firstname.lastname@example.org