Sunday, May 1, 2011

Investors Guru Small Cap Stock Observer

(Amex/TSX: URZ) Uranerz Energy - The Fukushima Time Machine For Uranium Value Investors?

In last month's article titled "Uranium Stocks After Japan Quake, Deep Dip Within Long-Term Uptrend" we wrote about the Japan Crisis that resulted from a triple-threat record earthquake, tsunami and the Fukushima Daiichi nuclear accident. We also made observations about the sudden sell-off experienced in the uranium industry from the commodity price of U308 yellowcake itself, to major producers of uranium and especially the small-cap uranium stocks we follow.

Every investor remembers the trade that got away, that you wish you had a time machine to go back and do over. Those who missed last fall's uranium bull market might now be asking if Fukushima has really caused any fundamental value change in the uranium industry, or like a time machine did it just wind back prices to where they were 6-months ago?

This time last year, in some of our Guru Trader Videos we identified small-cap uranium and potash as potentially great short-term, near-term and long-term value. As it turns out, small-cap companies of both commodities were top performers in 2010. As a side-note, the contrarian in us has again identified two areas that for no-good reason remain ignored and at multi-year lows, as the next potential great value for 2011 - that being natural gas and diamonds.

We especially liked uranium last year within a clear energy oil uptrend that was developing. At that time oil was over $80 a barrel while uranium severely lagged, stuck around half the price at $40 a pound. This seemed a no-brainer for uranium to catch-up to oil at some point, considering their highs of 2007-2008 were only $10 apart at $147 for oil and $137 for uranium.

Until March 11, 2011, and the Japan Crisis, this seemed a great call as last fall uranium started shooting higher, to over $70 a pound this year. Several small-cap uranium stocks showed impressive gains from mid-October to mid-February of 100% to over 300%. The 6-month comparative chart we displayed demonstrated that our Featured Stock since December 22, 2010 (Amex/TSX: URZ) Uranerz Energy was the top performer within a top performing sector.

Just a few weeks before the Japan Crisis uranium stocks sold off significantly and retraced some of their recent gains, which is normal within any uptrend. Nothing goes straight up forever. But then the Fukushima nuclear accident happened and uranium stocks sold off again... hard.

Markets hate uncertainty and for many the reaction is simply to get out of the way for a while. After a major natural disaster like the Japan Crisis this sell-off can be especially swift and deep. However, that was 6-weeks ago and investors should now start asking whether Fukushima is an industry game changer - or are uranium's long-term supply and demand growth fundamentals still intact?

As our last article indicates, these events are most likely a deep dip within a long-term uptrend. While everyone from the public to the media, to governments and the uranium industry and investors are trying to assess the situation, it might be a good time to learn from history.

You have likely heard about Crisis Investing, Misery Investing, or less sensational terms such as The Effects of Natural Disasters on Long Run Growth. Basically they all point to the behaviour cycle of initial reactionary panic selling that is usually far overdone, followed by rational assessment of fundamental value versus current below value market prices, and then a return to higher prices based on normal valuations and forward looking growth expectations.

This type of investor behaviour cycle is well established and can be demonstrated for all types of disasters affecting all kinds of stocks, industries, commodities or entire stock markets. In other words, everyone says buy-low, sell-high, and don't follow the herd, but they usually do the opposite. Sophisticated money managers are as susceptible to this behaviour as the average individual investor.

The initial selling is usually driven by liquidity concerns. This may be to secure margin requirements, or to provide recovery capital as in the Japan Crisis situation. If the markets were truly the determiner of an investment's real value, then investors would never sell below intrinsic value.

However, during panic selling this has little to do with the investment's fundamental value. Normal value decisions are instinctively overcome by irrational fear of the unknown. Bottoms are usually found when calmer heads again prevail, rationally realizing there is an undervalued opportunity.

Consider the market meltdown from 2007 to early 2009 when the S&P sold off from over 1500 to below 700, but is now over 1300 again in just two years. It boggles the mind how some analysts tell us to buy at several times the price they were telling us to avoid or sell the same investment two years earlier.

This behaviour is also seen in the price of (NYSE: BP) British Petroleum after the Gulf of Mexico Oil Spill Crisis of 2010 which saw its shares trade from over $60 to under $30, and now one-year later back to over $46 again.

Hindsight is 20:20 you say, and we don't have a time machine... or do we?

Now that the Fukushima time machine has slashed the prices of uranium investments, what long-term fundamentals have really changed? It is true that everyone involved will be looking to improve nuclear energy safety and that is always a good thing. However the switch back to fossil fuels is still not an option any more than it was before the Japan Crisis.

Nuclear energy is still the greenest form of commercially available mass energy. It is still far safer than oil or coal that powers the vast majority of the world's energy needs. In short there is no turning back the clock on our current nuclear energy production as this current uranium demand remains.

The real question is about future uranium demand growth, and will uranium supplies keep up to meet this demand. For years there has been a supply shortfall that has only been met by harvesting uranium from old nuclear weapons. At some point this supply will be used up.

Future supplies are insufficient and should continue to drive long-term uranium prices higher. Prices may pause a while longer as markets continue to digest the current situation, but after irrational emotions subside and the rational facts are realized, not much will have changed.

Developing nations such as China, India, South Korea and Russia are signing long-term contracts with companies such as Cameco and Areva. But uranium production is not keeping up.

For example, in early February, (OTC: EGRAF) Energy Resources shutdown the Ranger Mine in Australia to prevent their tailings facility from flooding. (NYSE: CCJ) Cameco's Cigar Lake mine in Saskatchewan has been delayed a few times due to flooding. (CAC: CEI) Areva's Trekkopje mine in Namibia won't be online until 2013, a year later than previously anticipated.

On the other hand China now has only 13 reactors operating, but they have about 27 more in construction and another 50 planned to start construction over the next few years - plus another 110 proposed. India has 20 reactors operating, with 5 more under construction and 18 more starting construction soon - plus another 40 proposed, etc. etc.

Worldwide uranium demand is 152 million pounds yearly for the 440 reactors now operating. China only represents about 15 million pounds now, but alone will add another 50 million pounds of uranium demand on top of that. If all of the proposed reactors are built this will be much higher.

The Fukushima nuclear accident has been compared to the Chernobyl nuclear accident that happened 25-years ago this week. Some argue Chernobyl was a man-made accident that wouldn't happen today, while Fukushima was caused by a natural disaster that could happen anywhere.

I'm not an expert but I don't agree. First is the fact that Japan uncommonly sits on three major fault lines that are prone to earthquakes. Second, Fukushima is 40-years old and is based on even older technology. It seems that today's nuclear crisis could have been prevented or at least substantially lessened if current technology had been in place.

On Feb 28, 2011 TEPCO (OTC: TKECF) Tokyo Electric Power Company submitted a report to the Japanese Nuclear and Industrial Safety Agency admitting that the company had previously submitted fake inspection and repair reports. In 2008, the IAEA warned Japan that Fukushima was built using outdated safety guidelines, and could be a "serious problem" during a large earthquake.

My understanding is that after the earthquake and tsunami knocked out the primary power at Fukushima, it was the backup power to the cooling systems that didn't work that created the real nuclear crisis. If they had their coolant tanks overtop the reactors, similar to newer nuclear plant designs used in China, these gravity fed water tanks could have cooled the reactors for days without any power.

Also older nuclear power plants were individually constructed and fitted as originals piece-by-piece onsite, whereas newer Chinese designs are factory built precision modules that are assembled onsite with fewer parts subject to human or mechanical error. Many new safety enhancements are now standard.

The fundamentals that motivated last year's uranium bull market appears to remain intact - a matter of when, not if, uranium will soar again. As a result of the deep sell-off caused by the Fukushima time machine, perhaps uranium should again be part of the next potential great value for 2011.

Here are some points worth looking into:
  • Fossil fuels are expensive and dirty and nuclear power remains the safest, greenest and lowest cost form of mass-produced power available today and for the foreseeable future.
  • Older nuclear power plants should be evaluated and upgraded if needed, and if this had been the case at Fukushima would there even have been a Japan Nuclear Crisis?
  • It's obvious that today's and future nuclear power plants will be built using safer technology than was used decades ago. This is already in place.
  • Uranium fundamentals remain solid, with future shortages likely. Uranium demand has outstripped production for years, and extra supply from nuclear weapons is dwindling.
  • Regardless, the Fukushima time machine has slashed uranium prices to 6-month ago levels. Oil is back up to $114 a barrel but uranium is only about half, at $56 a pound.
  • (Amex/TSX: URZ) Uranerz Energy traded as high as $5.93 in February and is currently trading at about half, closing at $2.78 on Friday. URZ has $46 million in the treasury and awaits final permit approval to commence construction of their first ISR uranium mine at Nichols Ranch, Wyoming.

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