ASX Weekly Wrap 26/06 - 30/06

Our last week of the financial year would have been more prosperous if it wasn’t for Friday’s 90+ point sell off. For the week we ended up a mere 5.6 points or 0.10%. Our low was 5,685.20 on Tuesday and our high was 5,819.70 on Monday. Volatility certainly being the theme for the month of June.

In a very quiet week for data China had two important data points released. Their National Bureau of Statistics released China’s manufacturing PMI for June and the number didn’t disappoint. The figure came in at 51.7, well ahead of the 51.0 forecasts and last month’s read of 51.2. This continues the theme of improving data coming out of China over the last two months and would help explain the recent turn around in commodity prices. This follows a similar theme to 2016 when it was around July data started to improve again and then we saw the massive rally in commodity prices and stocks. However you have to remember these were coming off much lower bases then so I wouldn’t expect the same rise this time around. Regardless this is very bullish for the XJO and global growth in general.

The second set of data to be released via China were their Industrial Profits for May. Profits increased by 16.7% from a year earlier, which was much higher than the +14% anticipated. This data captures the profit of large industrial companies with revenues of more than 20 million yuan per annum. Profits for the first five months of 2017 increased by 22.7% when compared to the same time last year. This was slightly below April’s +24.4% figure. Once again this shows the Chinese industrial sector is in great shape and turning some solid profits.

I am sure you are all aware we had the end of the 2016/17 financial year with the close of market on Friday. Thought I’d take some time to look back on what occurred during the year. As you can see from the chart above we had many headwinds present themselves before the XJO. From Brexit to Cyclones to a new bank levy the XJO was certainly up against it. Despite all that the XJO performed remarkably well. The index posted gains of +9.3% for the financial year and total returns, with dividends, of +13.1%. This was our best year within the last three. As you can see from the table below the only sector to give negative returns was the telecommunications sector with TLS, VOC & TPM dragging on the market. The best performing sector were Materials (i.e. Resources) with a +22.1% return. The table below that details the best and worst performing stocks for the financial year. I will skip the weekly sector and individual stock performance as it was fairly mundane.

Metcash (MTS) released their annual earnings result during the week which was generally well received by the market. Annual net profit fell 20% to $171.9mill due to its acquisition of Home Timber and Hardware and implementing its savings program. Excluding one off items its profit rose 9.0% and sales revenue rose 5% to $14.1bill. Whilst this was an impressive result MTS warned of further pressure to come in 17/18 with the entry of Amazon into the Australian retail space. It said it expected food prices to come under further pressure and impact overall sales. MTS is not a stock I am keen on. It’s in the same basket as other retailers where I only see earnings grinding lower due to Aldi and Amazon. There is some thought that MTS would be the type of company Amazon may be interested in taking over, mainly due to its distribution centers. It would provide retail sites for the ‘Amazon Fresh’ stores whilst also providing many distributions centers to send product out from. This was the very reason Amazon took over Wholefoods in the US. I believe this is a high risk play, but not out of the question. If MTS dropped substantially back below $2.00 it’s something I’d definitely consider.

Mineral Resources (MIN), the iron ore producer/mining services group released a downgrade on earnings late on Thursday which was surprisingly well received by the markets. I get the feeling the market had discounted MIN more and expected a larger downgrade hence why it bounced. MIN stated it would now expect EBITDA to come in between $460-$480mill, down from the $480-$520mill previously stated. It cited that a larger than expected discount for its iron ore produce was mainly to blame. MIN produces a 58% Fe rather than the 62% Fe you see me quote in the table at the start of this newsletter. This means they do not get the full price and get a discounted price for their iron ore as it is of a lower quality. They had anticipated a 25% discount but this turned out to be a 35% discount as many Chinese steel mills stopped buying the lower grade product and hence demand dropped.

As many of you know I am very bullish on MIN, but not for their iron ore. MIN has just started producing lithium which will boost its profits come 17/18. This could be another reason the market liked the announcement as MIN stated 2018 would be better because of this. In fact it is expected that MIN could be the world’s largest lithium producer once production fully ramps up in 2019. I am extremely bullish lithium due to the movement towards battery storage, especially within the electric vehicle market, hence I have started adding MIN to portfolio’s with a long term outlook. Anyone who follows me on twitter will be aware that I spent the majority of my Saturday night researching the global lithium market. I will summaries my research at the end of this week’s wrap and explain why I have turned so bullish on the mineral.

Commodities had a really strong week, but none more so than Copper. It broke through resistant to finish on highs of around 2.70lb. The chart above for Copper is as bullish as they come and it seems as if it will test older highs of around 2.80 in the near future. Copper is a great bellwether for global growth and has been on a bit of a run due to improved global sentiment, especially in Europe, improved Chinese data, a lower USD and the increased momentum in the electric vehicle (EV) movement. A lot of copper is used in electric vehicles. Other commodities such as Iron ore, Zinc and Oil also has fantastic weeks as well due to the above factors minus the EV. Iron ore rose off its lows of $54t to finish around $65t on the back of improved steel pricing and production in China. Oil bounced off its $43b lows to finish around $46.

Gold was probably the only negative performer. I put this down to the inflation story creeping back into play. US 10yr Treasury yields jumped from 2.16% to 2.30% during the week which came as a surprise to many. To me these yields are telling us that global cash rates will be on the move up again and that QE tapering could be expected in Europe and Japan within the next 12 months. Increased commodity prices will help with rising inflation, but I wouldn’t expect it to run away as long as oil remains so low. As we all know rising rates are negative for Gold, hence the selloff in the precious metal.

As I stated earlier I spent the majority of my Saturday night researching the Lithium industry on a global scale, demand/supply implications moving forward and how to obtain exposure here on the ASX.

Lithium

Lithium is a mineral not found naturally by itself in nature but rather in small amounts within igneous rocks (Hard Rocks) (Spodumene, petalite, lepidolite & amblygonite are most common) and in many mineral springs (Brine). Hence it has to be separated from the rock or spring in order to be produced and sold. The main produce of these, and what is sought after most, is Lithium hydroxide. A refined version of Lithium carbonate and where the demand for the industry is moving towards. Lithium is used mainly in rechargeable batteries for things such as laptops, cameras, phones and the new movement towards power storage and electric vehicles (EV). The last two are what we will mainly be focused upon.

Demand v Supply

It is estimated that in 2017 there will be 248,100 tons of Lithium produced and 250,000 tons consumed on the global market, hence the supply/demand balance sits on a knifes edge. These forecasts don’t include supply disruptions like the one that was just received from Orocobre (ORE) where due to bad weather it will fall short of this year’s production target by 2,500 tons.

In 2017 there has been a huge change in demand, to the upside, for Lithium carbonate and hydroxide due to an increased movement towards EV, mainly from China. As we all know Tesla’s Gigafactory will be completed towards the end of this year and start producing Lithium Ion batteries. They have also just announced they will be building a second Gigafactory in China only a few weeks ago. Add on top of that the new Gigafactory planned for the NT here in Australia and the three other factories in construction in China already. Plus there are many others in Europe and Asia planned or being built that all want to produce lithium batteries.

It is forecast by 2025 there will be 600ktpa of Lithium consumed and by 2030 up to 1.2mt. That is 3 – 5x our current consumption in the space of 14 years. By 2030 it is expected that EV will make up 30% of all vehicles on the road and by 2040 that will rise to 50%. In 2015 15% of all lithium consumed was for new battery technology like we see in EV. In 2017 that is expected to rise to 28%.

Australia currently is the second largest Lithium producer with 36% of the world’s total production. The first is South America, and namely Chile and Argentina, with 44%. China is third with 14%. In Australia it is dominated by hard rock production whereas in South America it in mainly brine. Thus as you can see from all of the above our use and demand of lithium will grow exponentially over the next decade and with Australia being such a large contributor to global lithium production it should provide us with plenty of opportunities to get exposure to the sector on the ASX.

Brine v Hard Rock

As I stated above there are two ways of finding and producing lithium at the moment. The first is brine which is much the same way we produce salt. High concentrations of lithium are found in mineral springs, mainly in Chile and Argentina, and the main process for extracting the lithium is letting evaporation occur and then for the lithium to be chemically extracted from what’s left over. Hard rock production is very similar to any other commodity such as copper, lead, zinc etc. You find a deposit of igneous rock, dig it up, crush it and separate the lithium out chemically.

Historically brine production of lithium was basically the only economical way of obtaining the mineral, however in the last decade, mainly in Australia, technology has in fact advanced so fast that the right hard rock deposit is often a lot cheaper to produce lithium. In fact it can be up to $USD500 cheaper per ton to produce. This is mainly due to the fact that obtaining lithium from brine is technically harder to do than from hard rock. Hard rock also benefits from the fact you can directly produce lithium hydroxide from it whereas with brine you must go to lithium carbonate first and then hydroxide.

Hard rock deposits must also ensure that they are mostly free from mica (quartz). If the deposit is high in mica it will increase extraction costs substantially as the rock has to be crushed much finer and then cannot be used within new battery technology. Both methods have their advantages and can both be economically viable but obviously hard rock will be the focus of most Australian lithium explorers.

Lithium Prices

Lithium is currently being sold in a range of $USD18,000 to $US21,000 per ton within China. Some battery producers are paying up to $USD25,000 per ton. As there are no real long term contracts in place for lithium the price is open to much further gains as Chinese battery manufacturer’s fight to secure their supply. Many factories are planning on tripling their lithium consumption by years end, hence are looking for many near term producers here in Australia to JV with to secure their supply.

What to look for in a Lithium Company

From my research I have found that there are few points to look for when analyzing a potential investment into a hard rock lithium explorer/producer:

1. Deposit must be close to surface: This is obvious as the closer to surface it is the less it will cost to extract and higher chance of an open cut mine.

2. Close to infrastructure- no point in having the world’s best lithium project if you are not close to existing infrastructure as it could potentially add billions to capex.

3. Lithium grades of 1%+: Once again you should be looking for companies with a JORC resource grade of 1%+. Most of the more profitable companies have grades around the 1.3% mark.

4. A resource of 20mill ton+: You want the resource to have some size. Most that are economical to mine will have a resource of over 20mill ton combined with a grade of 1%+. Anything less is probably too small, uneconomical or short lived.

5. Low concentrations of mica (quartz): You want there to be low concentrations of mica due to the higher production costs to separate the lithium out and then finer crushing. Spodumene deposits are generally seen most favourable for this.

6. Near term producer: you want someone who will be able to go into production within the next 2-3 years to take advantage of elevated prices.

7. No offtake agreements: Ideally you want a company that has not signed off to any offtake agreements as of yet. This means they should get a higher price for their lithium and are more open to takeover deals and large corporate investments from Chinese battery producers.

Exposure to Lithium on the ASX

There are many lithium explorers on the ASX as a lot went and bought projects during the last lithium run in 2016, but there are very few producers or near term producers. Most of the explorers won’t come close to producing, but doesn’t mean their share price won’t get caught up in the next lithium uptake. Below are a few of my favourite lithium companies listed on the ASX. Most are of a high risk nature and are not an investment for everyone.

Large Cap Producers

Orocobre (ORE) $3.48: Probably the purest of Lithium producer plays on the ASX. Has a market cap of $730mill+ and is producing lithium from brine in South America. Has had some production problems in the last 12 months hence the price has come off its highs. It is looking to double its production in the near future. Most analysts have a price target of around $5.00 on them.

Mineral Resources (MIN) $10.40: Market cap in excess of $2bill but also produces iron ore and has a mining services division. This de-risks the company somewhat but also doesn’t give you a pure lithium play. Has only just started lithium production in the last 6 months and plans to ramp up to full production in 2019 where it could be the world’s largest lithium producer. Is a hard rock producer in WA, Australia.

Small Cap Near term Producers

Pilbara Minerals (PLS) $0.375: Market cap of $550 mill and due to be a producer of lithium by March 2018. The Pilgangoora project is hard rock based in the Pilbara region of WA Australia. Currently in the process of raising capital via shares and bonds so there may be some short term dilution. Maiden ore reserves of 29.5mt @ 1.31% Li but with inferred resource of over 130mt. Looking to produce 2mtpa before ramping up to 4mtpa. Project has a 36 year mine life. Very close to infrastructure. 100% owned and low cost. Has offtake agreements with two major battery companies in China.

Altura Mining (AJM) $0.125: Market Cap of $190mill with also a 100% Pilgangoora lithium project in the Pilbara region of WA. Also low cost mine but smaller than PLS. 13 year mine life with resource of 39.2mt @ 1.02% Li. Close to infrastructure and mine commissioning due Q1 2018. Has signed two MOU with potential offtake partners.

Micro Cap Near term Producers

AVZ Minerals (AVZ) $0.036: Recently acquired a hard rock lithium project in the DRC called Manono. Could be the world’s largest known lithium deposit. Previously explored in the 1980/90s with many historical drill results. Just finished first drill campaign and waiting on results due in August. AVZ have an exploration target of 400-800mt @ 1 – 1.5% Li. Market cap of only $50mill so lots of upside could be had if they get close to their target.

Argosy Minerals (AGY) $0.075: Has three main projects located in Argentina. The main one and closest to production is the Rincon brine project. Currently constructing a pilot plant to produce 100-150t of lithium carbonate equivalent (LCE). MOUs signed with Chinese battery companies for offtake. By Q1 2018 hope to start development of 1k -1.5ktpa LCE plant.

Summary

As you can see there are many reasons to be bullish the lithium sector on the ASX as the EV movement gathers pace. I feel there will be a chance to benefit from this greatly in the next 12-18 months. As the use of lithium batteries for power storage and EV continues to increase it will be only a matter of time before the sector follows suite and is swept up in the excitement. I hope the above has helped clear up some areas within the sector and you can use it to your benefit in some way.

*As part of my research I used a lot of information from articles, and the knowledge, of Mr. Michael Langford of Airguide. He is a commodities specialist and in particular Lithium. His work can be found here https://www.linkedin.com/in/michaellangford1/recent-activity/posts/

A busier week lies ahead for the XJO with finally some decent data being released. China has it manufacturing and services PMI out. We have our manufacturing PMI released as well along with our trade balance and construction PMI. The US closes their market early tonight for the 4th of July national holiday. They are also closed tomorrow night. US jobs data is out on Friday night for June.

Had another busy weekend with some odd jobs done around the house plus we had a first birthday party to attend on Sunday. My 13 month old son enjoyed it somewhat, but wasn’t happy until he got given a balloon to play with. He has a major fascination with balloons and balls. I always enjoy kid’s parties mainly because of the party food. Can’t go past mini pies and sausage rolls plus the odd Frankfurt and fairy bread. I have at least a good decade ahead of me of kid’s parties to attend, so I better get used to it. Hope you all have a wonderful week ahead. I’ll speak to you all soon. Go Crows!

heath@hlminvestments.com.au

0413 799 315

Important Notice

Any advice in this article should be considered General Advice only and does not take into account your personal needs and objectives or your financial circumstances. You should therefore consider these matters yourself before deciding whether the advice is appropriate to you and whether you should act upon it. I am happy to assist you in this process. To do so, I will need to collect personal and financial details from you before providing my recommendations. Please note the author may own shares in the companies mentioned in the above blog.