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A Contrarian View of a Battered Mining Industry

A Contrarian View of a Battered Mining Industry

By Bob Kohut 11.02.2019


Newcomers to share market investing searching for “how to” advice quickly learn that most investing strategies have mirror opposites.

Value investors follow the maxim, “buy low, sell high”.  The opposite strategy is growth investing, where the maxim is “buy high, sell higher”.

While some might call these trading strategies rather than longer focused investing strategies, trend investing also has a mirror opposite.  The advice to follow the trend suggests “the trend is your friend.”  One could say this approach operates on the principle “50 million Frenchmen can’t be wrong.” This can be particularly appealing to retail investors without the time nor the temperament to investigate beyond the obvious appeal that if so many people are doing it, why not me?

In contrast, contrarian investors are often wary of wild upward rides in share price and look for opportunities in stocks trending rapidly southward.  Contrarians buck the trend, buying and selling in contrast to the market sentiment of the time, realizing sentiment is often more perception than reality.  In an ideal world, Contrarians take great pains to uncover realities that suggest market sentiment may be incorrect.

As examples, consider the market sentiment that followed the belief the mining boom was dead, savaging the share prices of iron ore miners and service providers alike.  While the resuscitation of that sector has not seen a return to the glory days of $160+ dollar per tonne iron ore, the sector is no longer on life support.  The following graph is from global data website indexmundi.com.


Experts are now speculating the price could soon exceed $100 per tonne.  Contrarian investors willing to take the risk that the demand for iron ore was not likely to go away and that miners could learn to be profitable with lower commodity prices were rewarded.  Fortescue Metals (FMG), a pure play iron ore miner, is up about 125% over ten years.


In a similar vein, Contrarians were skeptical of the supposed evaporation of the “golden age of gas” following a long series of cost overruns and production delays plaguing the LNG (Liquefied Natural Gas) sector.  In December of 2018 Australia overtook Qatar as the world’s leading exporter of LNG.

Even acknowledged megatrends such as the predicted explosion in the adoption of Electric Vehicles (EVs) in the next decades have been subject to stutter steps in the share prices of companies standing to benefit from the boom.  As more and more analysts and experts hyped the trend, the investing world looked for opportunities in the essential component of an EV – the battery.

Many of the metals that go into the construction of the current leader in battery production, the Li-ion battery, saw an influx of new entries and ramp-ups from existing miners of the commodity.

One metal that appreciated in dramatic fashion was cobalt, once in demand primarily for use in high-strength steel and super alloys.  The demand for cobalt skyrocketed to meet the needs of battery manufacturers, since the metal accounts for 14% of the battery cathode, one of the three critical components of a Lithium ion battery.

The cathode is comprised of lithium metal oxide, with differing formulations of metals.  The anode is comprised of graphite (carbon) while the electrolyte that separates them is comprised of lithium salts.  The following diagram is from batteryuniversity.com.


Cobalt is found in the two leading battery cathode formulations in use today -- lithium nickel cobalt aluminium (NCA) and lithium nickel manganese cobalt (NMC).  Cobalt is by far the most expensive material in the battery, largely due to its sourcing.

Cobalt is virtually always a by-product extracted from copper or nickel mining, making it subject to price fluctuations in the price of nickel and copper.  Few miners are willing to take on the cost of extracting cobalt, known as the “blue metal” when the prices of nickel and/or copper are depressed.

In addition, the leading supplier of cobalt worldwide is the Democratic Republic of the Congo (DRC), a country with substantial regulatory risk.  Mining practices deemed unethical, such as child labor, have earned cobalt the title of the “blood diamond of batteries.”

Given the supply issues, battery manufacturers and hedge funds alike jumped into that market dramatically increasing the price of cobalt well into 2018.


Two factors contributed to the collapse.  The price of lithium had already begun to decline following a research note from global investment bank Morgan Stanley predicting an oversupply of lithium by 2022, reducing price forecasts. Then global energy research firm Wood Mackenzie predicted a fall in the price of cobalt to $55,000 per tonne ($27.50 per pound) in 2019 before falling to further to $33,000 per tonne ($16.50 per pound) in 2020 and throughout 2021.

As is often the case when commodity prices skyrocket, supply increases eventually driving down the price.  In 2017 the world’s largest producer of cobalt announced the reopening of its Katanga mine in the DRC, in effect ending the perceived supply shortage at the time with the potential for oversupply conditions.

To add to the misery, Elon Musk of Tesla Motors, announced to the world he was looking to eliminate cobalt from the Li ion batteries for his EV fleet.  Panasonic and a leading manufacturer have also pledged to either significantly reduce the cobalt in cathode formulations or eliminate it entirely.

With the price of cobalt now down to US$14.97 per pound and its continued use in question, why would even the staunchest of contrarian investors be willing to consider investing in Australia’s fledgling cobalt mining sector?

First, some due diligence reveals factors that run contrary to the “doom and gloom” forecast.  What some investors missed in the early 2018 Wood Mackenzie note was the fact they said nothing about cobalt demand.  In an updated note from September of 2018, they had this to say:

Our base case view has cobalt demand essentially doubling by as soon as 2025, before demand growth really starts to accelerate as EV penetration grows. We remain of the view that the cobalt market will slip into surplus for the next few years.

While Wood Mackenzie appears to be pointing to the rising demand to be insufficient to absorb the supply glut they see, Bloomberg New Energy Finance on 21 May of 2018 offered a differing view:

“The long lead time to bring on new mines and the concentration of cobalt reserves in the Democratic Republic of the Congo mean there is a real possibility of supply shocks in the early 2020s.”


Trend investors might look to the search for a cobalt substitute as negating the existing demand forecasts.  Contrarians researching the issue can learn technical experts are highly skeptical a substitute can be found in anything less than ten years, if at all.

Cobalt is vital to both the performance and the safety of the Li ion batteries for EVs.  Reducing the cobalt in the cathode reduces the life cycle of the battery.  Safety, however, may be the strongest argument for maintaining cobalt.  Li ion batteries catching fire in cell phones, airplanes, and EVs gets the public’s attention and it is cobalt that allows battery cells to cool.

Australia has the second biggest cobalt reserves in the world.  The ASX has many entries in the space, but as yet none are producing.  Many are micro-caps, with market caps less than $10 million, with the attendant struggle to stay capitalised through the development process.

The following table lists three ASX stocks with market caps in excess of $100 million that are worth more than a look.


Clean TeQ Holdings Limited (CLQ) has the strongest balance sheet, as of the most recent quarter (MRQ), as well as an innovative technology for producing cobalt. 
 
The company’s proprietary Clean-iX® continuous ion exchange technology can be used for the recovery of both cobalt and nickel, another metal in use in Li ion batteries, from mining ore waste, or tailings.  Clean TeQ also has proprietary technologies for the treatment of industrial and municipal wastewater, Continuous Ionic Filtration (CIF®), Natural Evaporation and Crystallisation (NeX™).

Clean TeQ’s primary focus is the wholly owned Sunrise Cobalt Nickel Scandium Project in New South Wales.  The company has completed a Definitive Feasibility Study (DFS) and plans to begin construction in mid-2019 with first production anticipated in mid-2021.  Clean TeQ is pursuing a funding strategy that includes end users, private investors, and early purchase (offtake) agreements.  The company already has an offtake agreement for 20% of its production in place and is providing sample product for potential end users.  Clean TeQ also has a heads of agreement with the Metallurgical Corporation of China for project assistance.  Finally, Clean TeQ’s water treatment facility is under construction with commissioning expected in late 2019.

Aeon Minerals Limited (AML) has its flagship copper/cobalt project at Walford Creek in Northwest Queensland, with 100% ownership.  The company’s early estimate of the value of the cobalt deposit there was $4.4 billion dollars.

The company is a diversified miner, with additional exploration permits for gold, lead, zinc, molybdenum, silver, in Northwest Queensland.  Following successful drilling in 2017 the company announced an increase in its resource estimates for both copper and cobalt, claiming Walford Creek is now Australia’s largest copper/cobalt development project, with the highest-grade cobalt.

The company expects to complete a Feasibility Study in late 2019 following additional exploratory drilling and resource upgrades earlier in the year.  By mid-2020 Aeon expects mining license and environmental authority approvals. 
The share price was moving upward with positive drilling reports in 2018 but fell off following a mediocre report in late May.  Year over year it still managed to show a share price increase.


Australian Mines Limited (AML) has on its website its self-description as an emerging leader in technology metals for Electric Vehicles, with 100% ownership of multiple battery metal projects.  Its mining exploration operations are diversified, including cobalt, nickel, scandium, copper, gold, and other base metals.  The flagship project, supported by the Queensland government, is the Sconi cobalt-nickel-scandium project located in northern Queensland.  The company already has offtake agreements in place for 100% for Sconi’s cobalt and nickel production.

The latest Quarterly Update from Australian Mines, released on 21 January, showed impressive increases in cobalt grade as well as the news its current Mineral Resource and Ore Reserve estimates are to be upgraded, with results released by April of this year. The update was preceded by an announcement the company had received a $1.9 million tax rebate from the government for its Research and Development (R&D) activities, with sharp approval from investors.


The company has two additional cobalt projects underway; Thackaringa in New South Wales and Flemington, also in NSW.  Flemington is in the pre-feasibility stage while Thackaringa is in the survey and mapping stage, with a high-resolution helicopter-borne electromagnetic survey indicating possible cobalt-bearing rocks and other base metals.

The 100% offtake agreement for Sconi supports the company’s contention it is closest to production of any cobalt development project in Australia.  The agreement is with South Korea’s SK Innovations, a major producer of EV batteries with global plants under construction in China and Hungary with plans for a US plant as well.

As an added attraction for investors, scandium is used in high-strength aluminum and magnesium alloys, for use in cars and airplanes as well as for 3D printing applications.  Scandium is relatively rare and costly.  Australian Mines is partnering with a UK-based technology company, Metalysis, to produce a low-cost alloy.

Australian Mines has completed its Bankable Feasibility Study, with estimates of total free cash flow over the 18-year initial life span of the project of $2.6 billion dollars. 
 
The timeline to the first exports to a European battery plant in 2021 begins with final project funding and commencement of construction in 2019 to the commissioning of a processing plant in 2021.

There are other much smaller cobalt miners of note, among them:

First Cobalt Corporation (FCC) with a market cap of $15 million with projects in Canada;

Northern Cobalt (N27) with a market cap of $3 million and a project in the Northern Territory;

Cobalt Blue (COB) with a market cap of $17 million and a project in the Thackaringa area; and

European Cobalt (EUC) with a market cap of $20 million and projects in Slovakia and Finland.


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