CA - Radiating Opportunities: Yellow Cake And Sprott Physical Uranium Trust

2023-09-25 09:59:08 ET

Summary

• Yellow Cake plc and Sprott Physical Uranium Trust have seen significant gains since my last article in April 2023.
• Long-term contracted coverage rates in the US have increased, contributing to the recent movement in the spot price.
• The ongoing outperformance of U3O8 versus other commodities in 2023 is driven by the fundamentals, rather than by financial flows.
• The risk/reward of investing in uranium remains attractive, even though the possibility of purchasing pounds for a discount is over, for now.

Recap on 'The Nuclear Buying Opportunity'

Since my last article about Yellow Cake plc ( OTCQX:YLLXF ) on the 3 ^rd of April 2023, the stock is up about 44%. During the same time, the Sprott Physical Uranium Trust ( OTCPK:SRUUF ) gained 48%. The Sprott Uranium Miners ETF ( URNM ) rose 46% during the same period. Junior Uranium Miners are following in lockstep. Sprott Junior Uranium Miners ETF ( URNJ ) also posted a 48% gain.

The initial investment case appears to be unfolding right before our eyes. Since I published my article on the 3 ^rd of April 2023, the U3O8 spot market has surged by approximately 31% in just five months. Over the past six weeks alone, the spot price of uranium has spiked by $10, moving from $56.9 to $66.9, representing an impressive increase of 17.6%.

In this update article, I’ll discuss the progress of the uranium bull cycle and the sustainability of the recent price increase. I will provide an updated estimation of risk and reward of the uranium investment case, especially in perspective of weakening broad markets.

I suggest readers unfamiliar to the uranium investment case to read up on my previous articles about this subject: Yellow Cake: A Nuclear Buying Opportunity released in April 2023 and my two articles on the Sprott Physical Uranium Trust released in November 2022 and in June 2022 . I won’t go into detail about the basics of the uranium investment case in this article.

Overview of Yellow Cake plc & Sprott Physical Uranium Trust

Yellow Cake plc is a British uranium trading company established in 2017. The company's core business revolves around purchasing and storing physical uranium (U3O8) as an investment. Yellow Cake's primary goal is to offer investors exposure to the uranium market.

Yellow Cake benefits from a significant strategic advantage owing to its long-term contract with NAC Kazatomprom JSC (Kazatomprom), the largest and one of the lowest-cost uranium producers globally. The contract enables the company to procure uranium at a price agreed upon before announcing any intended purchase or associated financing, allowing Yellow Cake to acquire up to $100 million of U3O8.

Currently, Yellow Cake has acquired approximately 20.1 million pounds of U3O8 – unchanged since April - which are held in storage accounts at Cameco in Canada ( CCJ ) and Orano in France.

The Sprott Physical Uranium Trust primarily invests in and stores its assets in the form of U3O8 uranium in storage facilities located in the US, Canada, and France. Investors have the option to trade trust units through an at-the-market (ATM) program. When the trust shares trade at a 1% premium to their net asset value, the trust can issue more units to the market. These newly issued units are used to purchase additional pounds of uranium, thus raising the fund's NAV while reducing the available physical uranium supply.

Investing in Yellow Cake plc or the Sprott Physical Uranium Trust means speculating on rising U3O8 prices.

Continued uncorrelated performance

The resilience of the U3O8 price remains remarkable. During the Covid panic from March to May 2020 (highlighted in red below), most commodity prices experienced sharp declines. Commodities such as oil, copper, and iron ore, closely tied to economic activity, suffered as expectations of future growth plummeted. In contrast, uranium displayed significant strength, increasing from $24 to $34.

In Q3 and Q4/2021 the Sprott Physical Uranium Trust acquired approximately 23 million pounds of U3O8, and the illiquid spot market reacted sharply with a rise from $30 to $50 (highlighted in yellow) while other commodities remained stagnant or declined. The trust's announcement garnered interest from the broader investment community, far beyond the few uranium specialists. Many questioned the sustainability of these price increases because the majority of the buying was financially driven. A second spike of the same manner occurred in Q1/2022 – right at the pinnacle of broad market risk-on sentiment after the Sprott Physical Uranium Trust acquired additional 14.2 million pounds in one quarter. This spike proved to be of temporary nature (highlighted in orange).

Yet, as we entered Q2/2022, substantial financial tightening due to rising long and short-term interest rates led to a sharp reduction in inflows into speculative assets like Yellow Cake plc and the Sprott Physical Uranium Trust. There was almost no mandatory buying from those financial players. From Q2/2022 until now the Sprott Physical Uranium Trust acquired only 6.3 million pounds of U3O8. In 2023 the Trust only acquired 2.4 million pounds of U3O8. The financial players were in risk-off mode. The accompanied price increase of U3O8 from $46 to $66 (highlighted in green) happened because of organic demand, rather than financial fund flows. The ongoing outperformance of uranium versus other commodities in 2023 is driven by the fundamentals.

Ongoing long-term contract covering

In my previous article from April 2023, I discussed the increasing pressure on future contracted coverage rates in the United States:

US utilities have not covered all of their uranium needs for the next few years. While the future curve of contracted revenues doesn't look particularly tight, the uranium spot market does. If utilities are in a hurry to close long-term contracts while secondary markets are providing much less liquidity than before and inventories of UF6 have depleted, the U3O8 price could experience significant upward pressure.

The increase in future contracted coverage rates in the United States from April to August 2023 helps to explain the recent movement in the spot price, even without the participation of financial players. Long-term contracting has seen a significant uptick but hasn't yet reached replacement levels. In August 2023, term market purchases amounted to 118.0 million pounds of U3O8, while the total for the previous year stood at 125.0 million pounds of U3O8. If this trend continues, 2023 term market purchases are on track to surpass those of 2022 by approximately 20%.

Additionally, the U.S. Department of Energy recently announced the creation of a federal reserve of domestically produced uranium. The weighted average sales price from this initiative was $61.98 per pound of U3O8, representing a 30% premium compared to December 2022 when the spot price was at $47.75. If the U.S. uranium reserve continues to grow, alongside rising contracting coverage, it could generate more organic buying power for the U3O8 price to increase, all without the need for financial speculation to drive the market.

The discount window has closed & the speculation window has opened

During the risk-off period, I encouraged investors to accumulate positions because investment vehicles like Yellow Cake plc and the Sprott Physical Uranium Trust were trading at significant discounts to their net asset values. In April 2023, Yellow Cake plc was trading at a discount of approximately 13% to the value of its U3O8 inventory, while the Sprott Physical Uranium Trust consistently presented attractive buying opportunities from Q2/2022 to Q2/2023, often dipping below a 10% discount to its net asset value over the past year.

However, with the rise in the spot price and the broader market recovery, these discounts have narrowed. Yellow Cake plc is now trading at a discount of around 4%, and the Sprott Physical Uranium Trust is currently trading at par with its net asset value. Although Yellow Cake remains somewhat cheaper than the Sprott Physical Uranium Trust, the difference has become negligible in my view, considering that the Sprott Physical Uranium Trust has accumulated three times the amount of pounds of U3O8 and holds more significance for further accumulation.

There is not much left for the Sprott Physical Uranium Trust to enter a premium to net asset value above 1 % again. The Trust is then allowed to purchase additional pounds of U3O8 to close the premium – and to tighten up supply even further. This could create a – timewise unpredictable – flywheel effect which could corner the non-financial U3O8 buyers.

On one hand, the discounts have largely disappeared, and the potential upside from that source has diminished. On the other hand, more positive investor sentiment and increased fund flows into financial vehicles could stimulate demand for new pounds of U3O8, potentially driving prices even higher.

Broad market turmoil could affect miners and discounts of uranium investment vehicles

Even though the spot price of U3O8 appears uncorrelated with the broader market (as seen above during the COVID crash and U3O8 price), the uranium investment vehicles are not. All investment inflows into Yellow Cake plc, the Sprott Physical Uranium Trust, and uranium mining companies heavily depend on financial conditions and investor sentiment. It's unsurprising that the massive buying spree by Sprott in 2021 didn't continue into 2022 when global central banks began tightening monetary policy and the US dollar rapidly appreciated in value.

Currently, the discounts on uranium trusts have closed, but they are likely to reappear if the long-awaited recession eventually hits the U.S. economy. In the event of an acute liquidity crisis, every asset is typically sold to raise cash.

Key takeaways

The long-term fundamentals of the uranium bull market haven’t changed since my last article. The spot market remains tight, even with the significant increase in future contracted coverage rates. Clearly, the chance of purchasing discounted uranium via Yellow Cake plc and the Sprott Physical Uranium Trust have disappeared. Consequently, the risk/reward is not as favorable as it was in April 2023, as the fundamentals remain unchanged, and the U3O8 price has risen significantly. Furthermore, if the broader market experiences a downturn, the discounts of the uranium trusts could re-emerge, posing a risk of underperforming the U3O8 spot market.

However, the past year has validated the fundamental supply/demand narrative, with the spot market rising without the intervention of financial players due to risk aversion. The possibility of a bullish flywheel effect, where financial players corner the real buyers, remains a potential scenario which is impossible to time.

Given these factors, I have maintained my fully invested position that I accumulated during the risk-off period. However, I do not plan to add more to my position at this time. If I were not currently invested, I would cautiously consider initiating a position, taking into account the positive long-term supply/demand dynamics, the relative unattractiveness of the broader market in the medium-term, and the potential for an unpredictable flywheel effect. If the broader market experiences a downturn, and the discounts on uranium investment vehicles widen again while the fundamentals of the uranium investment thesis remain intact, I would consider additional purchases.

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