Investing

A friend recently suggested that I take a look at Cameco Corp (CCJ), a uranium miner and an operator of power generation assets. A few very smart people have written lately how the supply and demand dynamics of Uranium are likely to lead to much higher prices, especially as the recycled Uranium from the USSR is used up. While I basically agree that CCJ is geared to rising uranium prices the relationship is more or less linear, maybe CCJ rises 120% for a 100% rise in uranium. More significantly, I calculate that CCJ is within 20% or so of fair value, probably a little undervalued. All in all this doesn't leave me very excited about CCJ because I like undervalued commodity companies at today’s prices with leverage to their underlying commodity.

REVERSE ALCHEMY
It did, however spur another look at commodities in general and the companies that produce them. I looked into Lead this time around. The US Geological Survey, Mineral Commodities Study for Lead in 2004, provides a decent overview of the current uses for Lead and the US consumption and sources. 77% of US Lead consumption is from recycled Lead, more interestingly the June 2004 Monthly Report London Metals Exchange stocks of Lead dropped to 37.5k tonnes, down from 45.5k tonnes in June, 60k tonnes in May and 70k tonnes in April. Stocks were down to 32M tonnes in Mid September of this year but then jumped back to over 52M tonnes. Over 5 years, looking at a chart of inventories you can see that levels are incredibly low down from a peak of around 240K tonnes. Compare that with this chart for Zinc inventories. These reserve draw downs are relatively uncommon on exchanges where at the expiration of a futures contract, generally the parties settle for cash rather than actually drawing down inventories (a similar situation exists with silver). As a result Lead has risen from about $500 dollars a tonne to $980 a tonne today.

The International Lead Zinc Study Group, has identified in increased demand of about 1.6% worldwide (6.2% from China) in 2004 of 6.9M tonnes compared with a small mine output increase to 3.2M tonnes. The tables on this page show the rising world consumption of Lead since 2000 and the tiny increase in mine production which accounts for 45% of world consumption, the difference is made up through recycling.

Monetary factors also favor higher prices for all commodities. Members of the Federal Reserve have called for a significant drop in the US dollar and before the recent G7 meeting there was a call for a 20% drop in the dollar. That is aside from the potential inflationary effects of massive money supply growth over the last few years (see my post here for more details). As the dollar drops in value and inflation rises, commodity prices will hold their real value and appear to increase in value in US dollar terms.

As half of the world consumption of Lead is made up from recycling I tried to find out what the cost was for recycling a tonne of Lead from batteries. According to a European Union Study it costs from 400 to 900 euros a tonne (of batteries) to recycle. This tonne of batteries does not yield a tonne of Lead and across Europe this recycling ranges from a loss of 77 Euros per tonne of batteries to a profit of 93 Euros (probably excluding transportation). When all the costs are considered, the current price of Lead is pretty much between the cost to reclaim from batteries with no profit and a sizeable loss. Another interesting point is that Exide, the US battery company, is currently in bankruptcy and recycles most of their batteries to reclaim Lead for their new batteries. Exide could not compete with the Asian battery manufacturers that were not similarly shackled with government regulation.

IVERNIA, ivw
So with secondary (recycled or reclaimed) Lead pretty much unprofitable but government mandated, how would you like to own a supply of Lead that costs $335 a tonne and sells for $900+ per tonne. Well welcome to Ivernia Inc, IVW on the torronto stock exchange. They have 1.098 Million tonnes of Lead in the Measured and Indicated category as well as 565,000 tonnes in the inferred category. To be very conservative and only considering the M&I reserves they are valued at $47 per tonne of Lead (remember a tonne is selling for nearly 1000 dollars and costs around 335 dollars including capex and cash costs to mine).

Building a model for natural resource stocks is very easy and even more so for Ivernia as they only have one mine. I have assumed they produce 70k tonnes in 2005 and 90k t in 2006 through 2016. Total capex is 42.4M and cash costs are around 13c a tonne. There is slightly less than a 5% royalty, a small native title payment and Australian corporate tax that I have assumed to be 28%. The stock is currently trading at .94c Canadian/ .74c US and I calculate its value to be $2.43 Canadian or 1.92 US. This stock has at least 250%+ price appreciation potential WITHOUT A RISE IN LEAD PRICES.

That is the incredible difference between this stock and CCJ (the uranium company). With no change in the price of Lead, IVW has 200% price appreciation potential. A 100% increase in Lead prices leads to a 150% increase in the intrinsic value of the company and 350+ percentage points in price appreciation potential.

Ivernia is fully funded for its phase 1 capital expenditure program which will take them to 70k tonnes per year. The mine is located in Western Australia and has very little political risk.

SUMMARY OF THE INVESTING THESIS

• The current price for Lead is about where recycling programs can recycle batteries at between breakeven and a significant loss.
  
• Most Lead consumed comes from recycled sources
  
• Most of the Lead consumption growth is in China, a country less likely to recycle at current world averages meaning that growth in China disproportionately requires mine growth because they wont be able to supply from their own recycling program
  
• Lead inventories are at their lowest levels since 1990
  
• Inverina (IVW) has 150% leverage to price increases in Lead
  
• IVW is 250%+ undervalued based on my model with CURRENT LEAD PRICES
  
• IVW is fairly valued with Lead at $518 a tonne (23.5c a pound), a price that has been seen over the last 5 years
  
• Supply and demand factors favor higher Lead prices and so do monetary factors
  
• As IVW's mine will not produce for another 6 months or so; there could well be a catalyst for a revaluation once production starts.
  
• IVW is based in Canada and mines in Australia, any downward move in the dollar increases the value of Canadian and Australian assets (an upward move in Canadian and Australian dollars is likely as the commodity boom continues).