Will graphite be the black gold of the 21st century?

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

– Edited from an article by Michael Smedley


The black gold of the 21st Century. That’s how Kiril Mugerman describes graphite.

Of course, to most people, graphite is the stuff of which pencils are made. But Mr. Mugerman, an analyst with Industrial Alliance Securities in Montreal, isn’t that far off.  Nonetheless, mention metals and the majority of investors think of copper, gold or silver. They might also mention zinc, aluminum and nickel, although these metals attract far less attention.  But popularity really plummets when you speak of molybdenum, cobalt and tungsten.

Rare earths run below the radar as well, although they popped up during the last bull market because of demand from new technologies.  Still, as the lust for rare earths faded, a similar — and, even briefer — romance blossomed for graphite.

Lesson was useful

We got a recent update on that metal from the folks at Ottawa-based Northern Graphite Corp. (NGC-TSX/VEN, $0.71). And it was a good lesson, one that could be useful for making assessments during the next metals upswing.

For its part, Northern Graphite has a development site 100 kilometres from North Bay, Ont., just 17 km. off the Trans-Canada highway. As such, the site is obviously easily accessible.

Greg Bowes is Northern Graphite’s chief executive officer. A geologist with a background in gold exploration, most recently in the West African nation of Burkina Faso, Mr. Bowes is dedicated to bringing his company’s graphite mine into production in 2015.  If he succeeds, his company could boast the first new graphite mine in the West in over 20 years.

True, China now accounts for 60-70 per cent of global graphite supply. But Mr. Bowes thinks that because Northern Graphite is necessarily closer to North America’s steel manufacturers and automakers, he has a competitive edge.

After all, what company would want to wait six weeks for graphite to come from China when it could get it in one day from Ontario?

Moreover, Mr. Bowes says, China’s easy-to-get-to graphite deposits are getting used up.

Indeed, China has succeeded in becoming the big player in graphite because its labour costs have been cheap and its regulations have been lax.

Northern Graphite, meanwhile, says it’s the world’s most advanced prospective producer of the metal outside China, as well as the only such outfit with permitting in place.

Of the three main types of graphite now sold, demand is strongest for the large flake variety, which Northern Graphite hopes to mine. World demand for the metal hovers around one million tons.
In terms of both measured and indicated resources, the company’s mine should last for about 70 years. The company is planning a conventional open pit mine, one close to the surface.

In 2011-’12, when prices were highest, the medium flake form of graphite fetched more than US$2,500 a ton. But the large flake variety in today’s market likely now goes for about US$1,350 a ton.

In 2012, Mr. Mugerman estimated that if the metal hit US$2,100, Northern Graphite would have an after-tax cash flow of $21.9 million, as well as an internal rate of return of 22.3 per cent.
At US$1,500 a ton, his comparable numbers were $12.5 million and 11.98 per cent. These numbers are just a part of the complexities of the graphite industry.

Price is low

Clearly, the current price is well below its peak as is the case now with most, if not all, metals.  But for the long term, Mr. Bowes is optimistic, given what he believes will be a decline in graphite production in China, but a growth in demand worldwide.

In the meantime, construction of Northern Graphite’s mine is expected to start before the end of 2013, with financing being firmed up over the next few months. Actual commercial production is slated for the second quarter of 2015.

For the present, the company has enough cash to meet a low burn rate. It also has adequate lines of credit. Of the company’s 35 million fully diluted shares, 10 per cent are held by management.

But where is graphite used? It’s essential for anodes in lithium ion batteries; moreover, there are no substitutes. Indeed, your new Tesla won’t run without it.

Graphite is still used in pencils but batteries, refractories, lubricants and the auto and steel industries remain the biggest users.

The metal has the highest natural strength and stiffness of any material, is corrosion and heat resistant and is an excellent conductor of both heat and electricity. It’s also the lightest in weight of all reinforcements.

Moreover, for a hard substance, graphite’s lubricating qualities are unusual. And if you really want to know, the metal is only one of two natural carbon polymers, the other being diamonds.

If you read Mr. Mugerman’s overview of the graphite sector, you’ll see that it’s exceedingly complex.

Still, to give Northern Graphite its due, it now appears to have the third-biggest market cap — $100 million — among the more than 30 names Mr. Mugerman lists.

By comparison, the graphite outfit that’s in first place, Australia’s Syrah Resources, boasts a market cap just $62 million higher.

True, when it comes to market cap, Northern Graphite plays second fiddle to Zenyatta Ventures Ltd. (ZEN-TSX/VEN, $2.12).

Based in Thunder Bay, Zenyatta has an unusual vein-type deposit which, as is the case with Northern Graphite, is also located in Ontario. Production, though, would require a different approach.

Although Mr. Bowes makes a convincing case for Northern Graphite, he also thinks about the eventual formation of a specialized metals producer.

This leads us to fantasize about the strength of Colorado-based Molycorp Inc. (MLP-NYSE, $5.49).

At one time, the top U.S. producer of rare earths, Molycorp has since fallen into the experienced hands of a small group of Canadians who’ve set up shop close to our office in downtown Toronto.

Molycorp’s new crew were the competent managers of Neo Materials, the well-established industrial powders group which was bought out by Molycorp before the metals sector went into retreat.

Holdings are few

The Smedley Special Opportunities Fund, which is up about 21 per cent so far this year, has comparatively few holdings in the resource sector.  But we’re well aware that in this period of correction, gold stocks are very active and several base metals stocks — producers, explorers and developers — appear to have stabilized in the downturn.

Awaiting better times and not seemingly in harm’s way are mid-tier producers like Hudbay Minerals Inc. (HBM-TSX, $8.04), Imperial Metals Corp. (III-TSX, $12.13) Lundin Mining Corp. (LUN-TSX, $4.48) and Capstone Mining Corp. (CS-TSX, $2.61).

A handful of explorers and developers whose results look increasingly good include Pilot Gold Inc. (PLG-TSX, $0.82), and NGEx Resources Inc. (NGQ-TSX, $1.70).

On the bigger scale there are Teck Resources Ltd. (TCK.B-TSX, $27.91) and First Quantum Minerals Ltd. (FM-TSX, $18.59).

Still, the name that continues to pique our curiosity is Northern Dynasty Minerals Ltd. (NDM-TSX, $1.47), the sole proprietor of an immense copper and gold project at Pebble, Alaska.

But in developing Pebble, Northern Dynasty will no longer be able to rely on Anglo American, the U.K. mining giant.  After spending US$540 million on the project, Anglo American is pulling up stakes.

Its CEO, Mark Cutifani, says it was merely a business decision, although the pullout certainly moves Pebble into a new phase. Moreover, the project continues to face opposition from environmentalists.

Yet if Anglo American is gone, Rio Tinto Group (RIO-NYSE, $51.33), another mining giant, is still very much around, given its 20 per cent stake in Northern Dynasty.

In addition, Northern Dynasty still has the Hunter Dickinson Group. Indeed, the Vancouver-based global mining consortium remains the project’s guiding force.  And it’s now hoping to see some new direction regarding Pebble.
In the meantime, CIBC World Markets, a Bay Street heavyweight, has started covering Northern Dynasty.  Tom Meyer and David Galison, both CIBC analysts, note that seven years of work went into producing a US$120 million environmental baseline document for the project.

Messrs. Meyer and Galison also speak of uncertainty and confusion, which sounds a bit like the stock market itself!

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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