The Bigger Short

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The Big Short has become a cult classic movie amongst finance guys. Of course, we all know how the story ends, so there’s no suspense. Instead, the movie is a tale of hubris, and the downfall of a bunch of smug guys in suits. Meanwhile, our heroes are the handful of Wall Street misfits who figured things out, bet on the inevitable and then questioned their own sanity as the rest of the world ignored them, or even laughed at them.

Q2 2023 hedge fund letters, conferences and more

One of my favorite scenes is when the CDS buyers walk into the American Securitization Forum. The storyline throughout this scene relates to how everyone at the conference is confident, yet oblivious to the fact that they’re all about to get run over—meanwhile our CDS buyers laugh amongst themselves as they know what’s coming. As outsiders, they get the joke and none of the insiders do.

I felt similarly last week as I roamed around the World Nuclear Association (WNA) conference in London. It felt like I was attending The Bigger Short Conference. Out of approximately 750 industry attendees, maybe a dozen of us got the joke, and we were all finance guys. The industry guys seemed oblivious to the potential squeeze on supply. Just like there had never been a nationwide housing crash during the era of securitizations, there had never been a structural deficit in the lives of these attendees. Since it hadn’t happened before, no one had thought through the ultimate ramifications. In fact, most of the attendees were functionally short uranium, and getting shorter by consuming inventories, lending inventories or even selling down inventories. Meanwhile, those with contract coverage, had never even considered the counter-party risks entailed with doing business in funny countries with transport limitations.

Long-time readers of this site know of how enthralled I am with uranium. It is by far my largest sector exposure. Throughout the two years that I’ve been invested, the story has only gotten better.

I like to look at commodities in terms of supply and demand balances. Using very rough internal estimates that are likely to be directionally correct, if numerically incorrect, I believe that in 2024:

-primary supply will be 150 million pounds, and secondary supply will be 10 million pounds, for total supply of 160 million pounds

-meanwhile primary demand will be 190 million pounds, initial fuel loadings will be 15 million pounds, and overfeeding will require an additional 5 million pounds for total demand of 210 million pounds

-leading to a deficit of 50 million pounds

Now, there are a lot of assumptions going into this and I’m likely off by a few million pounds in each estimate, so anyone saying that the deficit will be between 40 and 60 million pounds is just as likely to be correct as my estimates are. Of course, this all assumes; that Cameco (CCJ – USA) hits their targets after guiding down production for 2023, that Kazatomprom (KAP – UK) hits their targets despite extreme difficulty in hitting production targets for a number of years, that Niger gets its shit in order, despite a coup and the shuttering of mining operations, that no other mines have technical issues, and that more reactors don’t get lifetime extensions or permissions to restart. Finally, this assumes no government stockpiling and more importantly, no investment demand that permanently sequesters pounds, despite investment demand by SPUT (U-U – Canada) and Yellow Cake (YCA – UK) in 2021 and 2022 running at 29.5m and 21m pounds respectively. As you can see, the deficit is large and at risk of growing much larger. The deficits could then expand for at least a number of years into the future as additional reactors come online and overfeeding becomes a bigger source of demand, while new mines take a while to finally start up.

I believe the deficits started in 2019 and have mostly been met with existing inventories and the drawdown of stockpiles. These pounds have bridged the gap, but they’re not inexhaustible. In fact, it seems that the era of excess mobile pounds may be ending and many at the conference seemed interested in increasing their inventory levels. Others complained about how it was becoming harder to source pounds from stable countries, and how various loans needed to be extended as the pounds weren’t available to unwind them. Yet, despite all of this evidence of a rapidly tightening market, most conference attendees were nonchalant about the future direction of pricing.

This situation is substantially different from when I initially put my uranium trade on. At that time, I thought that the trade was mostly about SPUT taking advantage of a small deficit to corner the market. Now, with my estimates showing deficits running at nearly 1 million pounds a week in 2024, SPUT is barely even a rounding error to overall balances. Rather, the trade is about the fact that an industry cannot function for long when deficits are running at a third of total supply. Oddly, in the uranium world, since there isn’t really a liquid market for financial speculators to achieve price discovery without taking delivery, we haven’t seen much more than a slow grind higher in the uranium market. This is simply the nature of an opaque and insular market with only a handful of consumers and even fewer producers. As a result, there hasn’t been the price response necessary to convince most miners to re-start mines or develop new ones—despite the universal belief that the deficits will be massive for many years into the future. When that price response does come, it will be too late as it takes years to re-start a mine and even longer to build a new one.

Returning to my Big Short theme, one of the most memorable scenes in the movie was when the CDS buyers interviewed two mortgage brokers who were blatantly doing risky business. I experienced very similar conversations this week as fuel buyers bragged about offtakes from non-producing mines, in countries with geopolitical risks, and how they had already resold those pounds to utilities, despite the mines not even having funding or in some cases permits. I spoke with utilities and enrichers who acknowledged a deficit but said that the uranium price would only go up a few dollars from here as the price was already historically high. I met traders who shorted inventory to investment vehicles and were confused at why those vehicles hadn’t sold pounds back to the market. I met consumers who complained that they couldn’t get shipments from Kazakhstan or Niger, yet had lent their limited stockpiles anyway, and were now below critical inventory levels. In summary, I met an industry who had no idea of what was coming. They’re nice guys, trying to do their job. They’re not dumb—in fact, most of them are nuclear engineers. They just have never contemplated that their little world has changed and their approach to that world hasn’t. At the WNA conference, these guys simply didn’t get the joke.  However, my finance friends sure did. In fact, all we could think of was how amazing this setup was.

Throughout my career as an inflection investor, I’ve showed up to sleepy industries that are starved of capital. I’ve dreamed that 100-Sigma events could happen, and I’ve frequently bet big. I’ve always been amused as industry participants told me that I was wrong; yet couldn’t explain why I was wrong. No one at WNA really disputed my deficit math. Instead, they seemed baffled that I even cared about their industry. Why were finance guys suddenly at their sleepy little conference?? Why did I care about the rapidly expanding deficits?? Didn’t I understand that they could just call their fuel buyer and get more pounds??

Let me be clear, I don’t think the world will run out of uranium. It’s actually quite plentiful as a commodity. However, there appears to be a gap period where for a few years, the deficits will simply overwhelm the ability to ramp up production. I think that there will be a super-spike in the uranium price. Not a doubling or a tripling, but a true super-spike that will stun everyone at this conference, especially as most of these guys are functionally short. Remember, as a utility, you’re not allowed to run out of uranium. If the price goes up, you simply chase it. Just because something hasn’t happened to uranium yet, doesn’t mean that it cannot happen. The fact that none of them are considering that this could happen, only increases the odds of it happening.

I went to a conference and expected participants to be concerned, maybe even spooked about the accelerating deficits, along with the increasing inability of Western consumers to access Eastern materials. The bifurcation of the market is a severe risk to every player with an offtake and even to the functioning stability of the industry. Instead, everyone sort of shrugged and said that prices cannot go up. As a veteran of inflection investing, I can assure everyone that prices can become irrational, far more irrational than anyone thinks is possible. Had I seen fear and panic, I would have known that we were in the end-game where utilities chase pounds. Instead, I realized just how early in this process we still are. There were hardly any finance guys, no bankers and certainly no booth babes. Just a few oddballs like myself who don’t understand how the deficits can stay this large for years into the future without an accident. The fact that no one else seemed to care, sure got me excited.

Let’s just say, I’m far more bullish today, than I was last week before the conference.

We will be releasing an interview with Mike Alkin taped live at the 2023 WNA Symposium later this week. Make sure to subscribe to Kuppy’s Korner.

Disclosure: Funds that I control are long U-U CN and various other uranium equities.

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Article by Kuppy’s Korner, Praetorian Capital.

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