Trader’s Narrative

It would seem that the stealth uranium bull market is over. After spending the past few years levitating non-stop into the stratosphere, uranium (U₃O₈) prices finally succumbed to gravity in June, topping out around $135/lb.

Since then prices have dropped to $90/lb (not shown on graph above). The effect on uranium stocks has been nothing short of devastating.

The Uranium Participation Units (TSE:U) traded on the Toronto Stock Exchange have dropped from almost $19 to $10. And whereas it used to trade at a premium to uranium spot price (sometimes as high as 50%!), not it is trading below NAV.

The last net asset value was July 31st at $14.04 - the August 31st numbers are still to come but I estimate them to be lower than July’s.

And while before it had bounced off it’s 50 day moving average, now it is below both the 50 day and the long term, 200 day moving average.

So what happened? I have no idea really. But I suspect it has something to do with demand and supply

Also, we had a rare contrarian indicator occur in early summer. At the beginning of May 2007, NYMEX started trading a new futures contract. Here’s what I wrote back then:

Historically, the introduction of a new contract has usually meant an intermediate high in prices…If you’re long uranium or uranium stocks though, we could be in for a rough patch as this is a reliable contrarian indicator.

As you can see on the chart, that coincides almost exactly with the top in Uranium Participation. Uranium itself hovered in thin air territory for another month or so:

I don’t like how most uranium stocks have cratered below their short term and long term moving averages. This sort of damage, especially when wrought over a short period of time isn’t at all conducive to the health of a bull market.

The only good thing I can see on the charts is that they are back at support (as you can see with the chart of Uranium Participation Units above).

Here’s a trading opportunity you don’t see every day!

On March 31st 2007 Uranium Participation Corp. (U) had a NAV of $12.38, while it traded for $16.00 on the Toronto Stock Exchange. After a spike up to a high of $18.76, it is now back to $16 a share (all amounts Canadian). That represents a premium of approximately 23% to the underlying commodity.

Since Uranium Participation represents actual uranium (the commodity), I’ll be going short the Uranium Participation Units and long the upcoming NYMEX UxC Uranium futures to arb out this premium. My only risk will be currency exposure between the US and Canadian dollar but since this should be a short term trade, that’s acceptable to me.

As of April 13th 2007, the short position of U on Toronto Stock Exchange, was 2,479,300 shares. This was a reduction from the 3,416,000 sold short on March 30th, 2007. I wish the exchanges would release this info with less time lag!

This trade is a great example of a non-directional trade. Although both positions are in uranium, the actual price of uranium doesn’t have to move for the position to be profitable. All that has to happen is a collapse of the NAV premium in Uranium Participation Units (U) to reflect the real uranium prices on the NYMEX.

By the way, this happened before when Central Fund of Canada Limited (CEF.A) - a closed-end fund in Canada investing in gold and silver - had its premium collapse after the introduction of the streetTRACKS Gold Trust ETF (GLD) and the iShares Silver Trust ETF (SIL).

Watch Out!
Historically, the introduction of a new contract has usually meant an intermediate high in prices. But since this is non-directional, it won’t affect me. If you’re long uranium or uranium stocks though, we could be in for a rough patch as this is a reliable contrarian indicator.

The other dark cloud on the horizon is that according to inflation adjusted prices, we are almost at the previous high (~$115/lb) last seen in the late 1970’s. After a parabolic move up within a few short years, I won’t blame anyone for being nervous to see prices at previous resistance levels.

Cheatsheet for the upcoming NYMEX UxC Uranium futures contract:

• U₃O₈ (yellowcake) is concentrated uranium oxide produced from uranium ore and is the most actively traded uranium-related commodity. Its primary use is as fuel for nuclear reactors.
• NYMEX UxC Uranium U₃O₈ futures will be launched at 6:00 pm May 6, 2007 (Sunday) for the trade date of May 7, 2007 (Monday).
• Contract symbol will be UX
• Contract size is 250 pounds of uranium U₃O₈ (currently spot price: $113/lb.)
• Minimum tick size is $0.05
• It will be a financially settled contract with each month settling on the corresponding spot month-end U₃O₈ price published by The Ux Consulting Company.
• Trading hours are 6:00 PM through 5:15 PM, New York time, Sunday thru Friday, with a 45 minute break each day between 5:15 PM and 6:00 PM.
• Initially, 36 consecutive months will be listed. The first listed month will be June 2007.

Doug Casey is an investment advisor and founder of Casey Research. Eventhough I don’t agree with everything he says, I really like his approach to the markets:

StockHouse: Tell me a bit about your investment philosophy - how is it different from others?

Doug Casey: I guess everybody at least likes to say they are a contrarian. But I try to walk the walk, not just talk the talk. … That’s one reason why I’m in Argentina. The blood was in the streets here in 2001, and it’s gotten vastly better since then. … So that would be number one-looking at contrarian opportunities that others are afraid of, or unaware of. Number two would be that most people tend to invest 100% of their money in something looking to get a 10% return. I’d rather invest 10% of my money someplace looking for a 100% return by going for volatile issues.

SH: There are a lot of investors very interested in some of these junior uranium companies, but you have some concerns about them?

DC: Yes. On the one hand, I’ve always been a big believer in nuclear power. It’s not only by far the safest and cleanest, but it’s almost certainly the cheapest form of mass power available. The only reason I don’t say it’s definitely the cheapest is because the government is so involved in nuclear power with subsidies and taxes and regulations, you can’t tell what the true economics of anything really are. But eventually the truth will be out. There are going to be hundreds of nuclear power plants built in the next generation all over the world. And they mostly run on uranium. Now there’s plenty of uranium in the world; it’s not, for practical purposes, a diminishing asset like oil. That’s the good news for society.

But right now, the world is living out of inventory; we’re only mining about 60 % of the uranium that’s being consumed. So as far as the fundamentals of uranium are concerned, I think it’s going a lot higher. I think we’re going to see $100 uranium in the next few years, and that’s going to result in the stocks of some of these uranium companies just going to the moon. That’s the good news for investors. The bad news is that whereas five years ago you had a handful of uranium companies out there, now you’ve got something like 200 companies that either have uranium in their name or claim that they’re looking for the stuff. So these companies have grown like poison mushrooms after a rainstorm and most of them are going to be disasters as investments.

Although there’s another old expression in this business-when the wind blows, even the turkeys fly. So some of the worst companies that have the worst chance of ever producing any uranium could turn out to be the best stocks to own because the management is going to concentrate much more on promotion in getting the public to buy those stocks.

Source: StockHouse Editorial.

For the past 3 years, there has been an explosive bull market in uranium (and uranium stocks). But it has been almost totally ignored by the media and the average trader. Especially when compared to coverage of the bull market in oil, gold and silver. If you want to take advantage of the uranium bull market, you could of course go long uranium mining stocks. But thanks to a security traded on the Toronto Stock Exchange, you can buy the actual commodity:

Uranium Participation Corporation is an investment holding company created to invest substantially all of its assets in uranium, either in the form of uranium oxide in concentrates (”U₃O₈“) or uranium hexafluoride (”UF₆“), with the primary investment objective of achieving appreciation in the value of its uranium holdings. The objective of the Corporation is to provide an investment alternative for investors interested in holding uranium.

But I would think twice before buying it here because it is trading at a whopping 50% premium to NAV (latest NAV released by the company was for March 31st at $6). Granted, since its IPO, U has always traded at a premium. Probably because it is the only way to invest in the commodity itself. But a 50% premium is ridiculous. I would patiently watch for an orderly pullback (with low volume) and allow for a more palatable entry.

Here’s a historical chart of U₃O₈ prices to give you the bigger picture:

Source: UxConsulting