Should You Buy Into the Lithium Mania?

Few things get investors’ attention quicker than a good, old-fashioned financial mania.

Whether it’s Dutch tulip bulbs in century or Internet stocks in 1999, a chart like the one for lithium below gets speculators’ hearts pumping.

After spending years in the dumps, the price of lithium began to skyrocket over the past year or so. In China, lithium carbonate spot prices soared from $7,000 per ton in October 2015 to over $25,000 per ton within about nine months. Although prices in China have pulled back recently to around $20,000 per ton, lithium carbonate contract prices elsewhere are rising or stable around $8,000 per ton and around $12,000-$13,000 in China.

Experienced speculators know that financial manias all end poorly, with the majority of mom n’ pop latecomers losing their shirts.

As Robert Friedland — well known in the mining community for some wildly speculative forays into the mining sector of his own — recently put it:  

“The lithium market will end in tears.”

With that said, unlike the Dutch tulip bulbs, there is a robust and lasting fundamental case for lithium — one that virtually guarantees that demand for lithium will continue to soar even if prices do correct sharply.

The Electrical Vehicle (EV) Revolution

Demand for lithium first exploded alongside the widespread adoption of mobile devices such as smartphones, laptops and tablets. Each of these devices requires light, powerful, rechargeable batteries to operate reliably. The chances are that every gadget you have owned in the past 20 years contained some lithium.

Although lithium batteries are ubiquitous, these mobile devices aren’t going to be major drivers of future demand growth.

Goldman Sachs predicts that the largest source of lithium demand over the next decade will stem from the widespread adoption of Electrical Vehicles (EVs), with demand for the “white petroleum” tripling by 2025.

If that sounds far-fetched, remember that an average EV requires 100 times as much lithium carbonate as a laptop does. And a Tesla Model S requires 10,000 times as much lithium as a smartphone. To hit its current production targets, Tesla alone will have to consume the majority of all the lithium produced globally today. That explains why Tesla is building an enormous $5 billion, 35-gigawatt-hours “gigafactory” in Nevada to churn out lithium-ion batteries for powering its sleek EVs.

More generally, the International Energy Agency forecasts 20 million electric vehicles (including plug-in hybrids) will be in use by 2020. Within a decade, EVs will account for 38% of all lithium demand, compared to only about 6% today.

The Future is Energy Storage

Although it’s the growth of EVs that is capturing investors’ attention, energy storage is a whole new source of exploding lithium demand.

That’s because lithium also powers the batteries that store renewable energy generated by solar panels and wind turbines. With an emphasis on “green” and “renewable” energy around the world, the use of wind turbines and solar panels is taking off. For instance, Germany — the world’s fourth largest economy — generated 30% of its electricity from renewables in 2015, compared with 6% about 15 years ago.

Thanks to the declining costs of lithium-ion batteries, battery storage is now economically feasible for some energy storage applications. No wonder installed battery capacity in energy storage products has doubled in two years. As renewable energy expands, so will the demand for large, lithium-powered storage batteries. And the future of energy storage is only set to accelerate.

Two Challenges of Investing in Lithium

With lithium’s recent spectacular price gains and blue-sky prospects, investors are actively seeking ways to invest in this white hot asset.

Two large challenges lurk.

First, it’s tough to gain exposure to lithium directly. Unlike many other commodities, you can’t buy lithium on any major commodities exchange. You can’t gain exposure through futures contracts or swaps. The only way you can invest in lithium is by investing in individual lithium miners of through a basket of stocks.

On the one hand, the lithium supply market is dominated by four major producers. Albemarle (ALB), FMC Corp. (FMC), Chile’s Sociedad Quimica y Minera de Chile (SQM) and Sichuan Tianqi together accounted for 83% of global supply in 2015. On the other, lithium only accounts for at most 13% of each company’s business.  So you’ve got to dig deep into the world of speculative small caps to find a pure play on lithium.

Second, like any asset that has tripled in price over the last 12 months, lithium is likely in a speculative bubble. Australian-based analysts at Macquarie recently suggested that with so much new supply coming to market, the lithium market will shift to oversupply starting in 2017. That, in turn, is likely to put downward pressure on lithium prices.

Now this doesn’t change the compelling fundamental case for investing in lithium.

Nor does it mean that you can’t make money by investing in lithium-related stocks.

It just means that in the current state of the market, you have to recognize that speculation in lithium stocks is like a game of musical chairs.

Just make sure that you have a chair to sit on when the music stops.
P.S. I recently recommended my top lithium-related stock to my subscribers of The Alpha Investor Letter. If you want to find out the name of this stock, click here and subscribe.

In case you missed it, I encourage you to read my e-letter column from last week about how the U.S. could learn from the Chile’s mistake in its pension system. This article, and many other past Dividend Investing Weekly columns, can be found on StockInvestor.com, new home of Eagle Daily Investor. I invite you to bookmark the site and follow it on Facebook and Twitter.