Can lithium hold its charge?

Summary: Producers of battery metals – a group that includes lithium, graphite and cobalt – are racing ahead on the stock market, with company case studies listed below. There are signs a speculative bubble is growing.

Key take-out: Investors should note both the top and bottom ends of the local resources sector are well-exposed, and potentially overexposed, to battery metals. There are concerns about the prices that early movers – both companies and investors – are paying for lithium assets, some of which are thought to be of inferior quality. New reports on demand coming out of China are also less than encouraging. 

Few events are more annoying than a flat battery, especially for motorists in a hurry, but it could also happen to investors in what looks to be an overheated sector of the stock market.

The question of whether battery metals will go flat, or worse start to reverse, is relevant to the top and bottom ends of the resources sector. Battery metals is a group that includes lithium, graphite and cobalt.

At the top end, BHP and Rio Tinto are showing increasing interest in battery metals – BHP through its investment in expanding nickel-chemical production to supply battery makers, and Rio Tinto through an emerging interest in lithium.

At the bottom end, there is a large and growing speculative bubble in the share prices of companies exposed to battery metals with many doubling, and better, over the past few months thanks to a belief that the world is rushing towards a future dominated by electric cars.

Pilbara Minerals, a sector leader, has rocketed from penny dreadful status to a $1 stock, with a market value of $1.6 billion thanks to its Pilgangoora project in WA. Orocobre, another lithium stock with the advantage of actually producing lithium, has shaken off uncertainty to trade close to an all-time high of $6.25 and a market value of $1.3 billion.

It's a similar story among cobalt-exposed stocks, where a whiff of the relatively rare metal can drive a stock up sharply. Last week Archer Exploration reported encouraging assays from a drilling campaign to enjoy a 150 per cent price rise from 7.7c to 19c, before easing back.

No one doubts that electric vehicles will carve out a share of the car and truck market, but as with most change it might take longer for a bright idea to become a viable business. The risk is that early movers are overpaying for assets, both in the ground and on the stock market.

One way of testing the rush into battery-powered cars is to examine how many are actually being sold to private buyers. A report from China indicates that even heavy government subsidies are not encouraging a widespread shift from conventional to electric vehicles.

According to a Wall Street Journal report last week from the Guangzhou Auto Show, only 38 per cent of customers buying the Baojun E100 electric car were private, the rest being government agencies.

Carmakers are being encouraged by government to switch production to electric cars to help reduce pollution levels in major cities – but even with government subsidies, sales are faltering.

Other signs of an industry which has moved ahead of its underlying market can be found in the way long-term players in the battery metals business are balking at asset prices.

US-based Albemarle Corporation is already a major lithium producer in Australia via its 49 per cent stake in the Greenbushes mine in WA, and wants to further expand its resource footprint to feed a processing plant under construction at Kwinana, south of Perth.

Albemarle chief financial officer, Scott Tozier, said the company was actively seeking acquisitions but was finding that many lithium assets being offered were not as good as promised and the price being asked was simply too high.

Those remarks – admittedly from a buyer seeking the best price – could be a warning to novice investors in battery metals. Professionals are taking a step back because asset values are overheating.

The next important test of the appetite for lithium assets will come when a 32 per cent stake in Chile's biggest lithium producer, SQM, is sold by the Canadian company, Potash Corporation.

Rio Tinto has been named as a possible buyer of the SQM interest, along with Chinese chemical companies, including SinoChem, with the asking price believed to be as high as $US5 billion.

Potash Corporation is selling its SQM stake in order to win regulatory approval to merge with fellow Canadian fertiliser producer, Agrium.

If Rio Tinto does buy into SQM it will get a stake in a well-established, world-class, lithium business which has already expanded out of Chile and into Australia via a joint venture with Kidman Resources on the Mt Holland lithium discovery in WA.

A position in SQM would also complement Rio Tinto's emerging Jadar lithium and boron discovery in Serbia.

Attractive as it might be to enter the lithium business, there are warning bells ringing about the prices being paid for lithium assets. Several observers are pointing out that Rio Tinto has a bad track record when it comes to asset acquisitions.

The high-priced Alcan aluminium acquisition a decade ago was ill-timed, as was the failed attempt to enter the African coal sector through the acquisition of Riversdale coal.

Interestingly, both the Alcan and Riversdale deals occurred at the peak of the market for aluminium and coal assets.

In theory, that makes Rio Tinto's interest in SQM an interesting test of the lithium market, which could appear to be approaching a peak.

It might sound odd to see Rio Tinto as a guinea pig, but if it does bid for the Potash Corporation stake in SQM, it might be perceived as a lithium sector ‘sell' sign.