The Long Term Bull Market in Molybdenum

Molybdenum (Mo) is one of the many industrial commodities that languished in the 1985 – 2002 period. It was characterized by low prices, low or negative investment and a lack of interest by consumers except as a routine item. Additionally, much of Mo is copper byproduct, and the low copper prices caused miners to maximize moly production as much as possible.

This all came to an end in the ‘00s as steel demand growth in the developing world blew out. Moly went through much the same process as other industrial metals, with prices rising about eight times. The structural situation, however, may be even stronger than some others.

Supply / Demand

Estimates of moly supply/demand are confusing, with discrepancies between sources. However, all agree that inventories of moly have been reduced to very low levels. Previously, many of the stocks were carried by dealers; consumers and producers kept inventories just in time. The eight times price increase has made it too risky and costly for dealers to continue in this role. There may be speculative stocks held by private speculators/hedge funds etc., but in the following I assume that there will be no stock drawdown from hereon.

Usage of moly has grown 3.2% per annum over the past ten years. However it has grown 6.6% per annum over the past five. Partly this is due to strong emerging markets and infrastructure buildouts over this time period. There is reason to believe that there is a structural element to this as well.

• Moly steels are stronger and lighter. On vehicles they are a gas saver. Many observers see a higher use of alloy steels here.
• Because of strength and corrosion resistance, moly steels are also heavily used in oil/gas drilling, especially in deeper wells.
• Moly stainless substitutes somewhat for nickel stainless and currently has a significant price advantage.
• Moly is used as a catalyst in fuel refining. It is the major catalyst used in making ultra low sulfur diesel – potentially a big growth story in Europe and the USA.

For this analysis, I will also assume that potential demand will grow by 4.5% per year. Actual demand will be constrained by production.

Future moly supply hangs on new mine openings and Chinese exports. As in all mineral markets, there are a huge number of explorations going on, most of which have little chance of going forward. The mines I include here are those I think have a high probability of coming to fruition.

The Chinese situation is somewhat confused. China has effectively banned all toll roasting of moly, indicating a tight situation. There are reports that production of concentrates at state-owned mines are up, but private mines are down. I will assume that the growth in the Chinese economy will slowly reduce exports.

See the table at the top. All figures in million lbs. Mo equiv:

The take-away from this is that there can be no significant moly stockbuilds until the end of the decade. After that, if all things go well (a big if), it can resume a more normal market.

Prices

There is no way to accurately forecast moly prices. This is a situation of zero surplus stocks, but very high current prices. However in view of the above, it seems reasonable that prices will remain quite high until 2010. The 1960 – 2006 deflated average price is $14 / lb. In light of the strong fundamentals, this should probably provide a long-run floor.

Investment Possibilities

Moly metal forwards are very difficult to get. One could buy cash and hold it, but in view of the price level, that is a poor idea. If it could be traded, one would guess that there would be a hefty backwardation in moly metal.

Possible equity plays:

The best mine in the world is likely to be the reopened FCX Climax mine in Nevada. Reputable sources claim it will have an operating cost of $3.50 per lb. Unfortunately, FCX is clearly not a pure moly play, but if you were decide to go long copper or gold stocks, this would be a consideration.

General Moly (GMO). They are developing a new mine in Mount Hope Nevada and own another high grade moly claim nearby. This is one that looks like it will get done. It will take about $1 billion. Investors include the steel companies Arcelor-Mittal and POSCO (Korea). This is important because they will become dedicated consumers as well. The funds Coghill, Sprott and Citadel are also in. Production is scheduled for 2H 2010. This is a claimed low cost project – total operating cost including an onsite roaster is $7.65 / lb., and a moly price of $15 gives a claimed IRR of 25%. Grade is high for an open pit at 0.1%. One downside: some think the 2010 startup is optimistic, maybe very optimistic. http://www.generalmoly.com/gmo1dir/investors.htm

Molymines (MOL.TO). This project is backed by some of the same principals behind Fortescue Metals Group, a very successful Western Australia mining venture. This is probably a slightly higher cost project. However it is located closer to the expanding markets in Asia. Grade is 0.06%. One advantage is access to ultra cheap Aussie natgas for power. Also, there may be other economic minerals on the claim, especially iron ore. If so, there could be significant upside.

http://www1.molymines.com/default.aspx?id=1&category=1&Ddte=1&DGrd=1

Adanek (AUA.TO). A smaller producer. This should be the 1^st new moly project online.

http://www.adanacmoly.com/index.php

Thomson Creek (TC). This company operates the Thomson Creek mine in Idaho and another in BC. It has a PE of 16, P/B of 4.3. They also have a Mo roaster in PA, which also does toll work. This would seem to have lower risk since it is already in operation. However, production at both mines has been below expectations.

http://www.thompsoncreekmetals.com/s/Home.asp

The Trade

General Moly (GMO) seems the pick of the litter here. Molymines (MOL.TO) also looks good, especially in view of the track record of the principals.

For those who want to be market neutral, hedging new ventures is difficult. The betas of GMO and MOL.TO are statistically unreliable. In reality this is going to be quite nonlinear. In a major economic meltdown, these stocks could go to near zero, while a 10% correction might mean nothing for the long term. To partially hedge, I am buying XME puts, strike at 10% under the market.