Investors eye uranium opportunity

(June 2007) Uranium prices have been rapidly rising as fears about nuclear fallout are replaced by ones about climate change. The markets have responded by offering a host of investment products that let retail investors get a piece of the action, including recently introduced futures trading on the NYMEX. Even advocates of uranium stress that, like any commodity, strong returns are propelled by a higher level of risk and volatility. Investors looking to get into uranium need to understand what’s propelling the market and why the pros have decided to place their bets on it.

For years uranium prices have been depressed as fears of another nuclear disaster have led to more nuclear plant closures than openings. Of late, there has been a growing confidence in the safety of nuclear power and, with fears about climate change forcing energy producers to look for alternates to coal-, oil- and gas-fired generation, nuclear’s track record as an efficient fuel has become much more attractive.

Until recently, uranium exploration has been limited, and there is currently a gap between supply and demand. Since uranium mines are not the sort of thing that can be opened on short notice, analysts expect supply will significantly lag behind demand over the next few years, forcing prices to rise.

Bob Tebbutt, a commodities specialist and vice-president of corporate risk management at Peregrine Financial Group Canada, says this lag makes uranium a potentially successful future contract, because it’s attractive for speculators. But he points out that what’s good for speculators is not necessarily good for individual retail investors. Right now, investors in uranium futures are banking on demand to outstrip production, and cash is pouring into speculative mines that have potential but no active operations.

“Any commodity’s risk/reward is based on volatility,” he says. “Speculative mines are more in it for the attraction that uranium has for penny mine traders,” he says. “Would they be interested in hedging? Not until they become producers, and I don’t see them becoming those yet.”

Fund companies are not ignoring the potential of uranium for buy-and-hold strategies. The two largest publicly traded uranium companies, Cameco Corporation and sxr Uranium One, are both based in Canada, so there is an opportunity for Canadian-focused funds in particular to diversify their energy holdings beyond oil and gas.

Richard Nield, portfolio manager of the AIM Canadian Premier Fund, says his fund prides itself on underweighting commodities to avoid their cyclical nature, but he admits uranium is an interesting proposition, at least for the next few years.

“Uranium is interesting because there is plenty of uranium in the ground. Usually it’s more about getting the permits and environmental approval. Many times, mines are taking seven, or as long as 10, years from the planning process to when you’re actually mining production,” he says. “Those are very long lead times and for that reason you can still make an argument that those supplies will remain a challenge, which should cause prices to have some sort of a downside protection.”

It’s this downside protection that Middlefield Capital Corporation has targeted with its Uranium Focused Energy Fund, a closed-end fund that is the product on the market to specifically target the world’s appetite for uranium.

“There is a lot of uranium in the ground. It’s going to take seven to 10 years until you get enough supply to satisfy the demand,” says Dean Orrico, managing director and chief investment officer of Middlefield. “This is a six-and-a-half-year fund. We’ve actually structured the fund to take advantage of this window of strong uranium prices.”

The uranium fund diversifies their holdings across the industry, focusing primarily on large-cap producers and what Orrico refers to as “mirror term” producers, which are anticipated to go into production within the next few years. Orrico says the fund does have minimal investment in some speculative and exploration companies that have been carefully selected.

To further mitigate risk, Middlefield can invest up to 40% in other energy commodities, which, Orrico says, are mainly in oil sands companies and infrastructure.

Nield emphasizes that at the end of the day, energy investing is investing in resources, so investors have to accept the greater volatility that comes with those markets.

“You’re going to have ups and downs. Weather seasonality plays a big part; supply is a big deal, and companies are spending more to drill,” he says. “Exploration will also remain a challenge. This will be the same for any other resources, whether you’re in nickel or copper.”

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com