Shani Jayamanne: Welcome to Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Mark LaMonica: Today we are going to talk about lithium Shani.

Jayamanne: A topic that we know people are going to be interested in.

LaMonica: Yes. And that interest does not stem from it’s use as a mood stabilizer. Everyone is talking about lithium because it is a key component of the batteries that go into the batteries that are used in electric vehicles. Depending upon the model, a Tesla battery contains between 5 and 75 kilograms of lithium.

Jayamanne: And electric vehicles of course fit nicely into the theme of climate change as the more electric vehicles there are the less oil we consume.

LaMonica: And there we have. Lithium goes into batteries and batteries go into electric vehicles and electric vehicles solve climate change. Case closed. Buy lithium, get rich and fix the world.

Jayamanne: I guess we should request comments and ratings in the podcast app.

LaMonica: Not quite so fast Shanika. Listeners have a bit more time listening to my raspy voice and your sweet voice as our listener Luke emailed us.

Jayamanne: It was a lovely email.

LaMonica: Your voice got described as sweet so I can imagine you would think so. But it was a really niceemail Luke. We need to continue this episode because the focus on lithium includes some things that we need to watch out for as investors. We need to guard against blindly getting caught up in hype.

Jayamanne: And none of this means that buying lithium miners is a bad investment. We want to share a balanced view that lets people decide for themselves if they want to pursue this investment opportunity.

LaMonica: Lets start with some facts. In 2015 electric vehicles made up .7% of total car sales. In 2022 they made up 14% of car sales. So clearly demand for electric vehicle sales are increasing. And lithium prices have followed this surge of demand. In 2015 lithium was priced at $5,125 USD per tonne. By December 2022 prices had reached $80,000 USD per tonne.

Jayamanne: And we talking about lithium carbonate prices here which is what is used in the batteries. But the price increase of lithium has unsurprisingly led to increases in production. Lithium production hit 100,000 tonnes for the first time in 2021 which is four times what was produced in 2010. And around 90% of it came from four counties – Australia which leads the world by more than double the second place producer which is Chile and then followed by China.

LaMonica: And the fact that Australia produces so much lithium is of course why we are talking about this topic and doing this podcast right now. Now although Australia is huge producer at 52% of 2021 production China is a huge player in this market. Not only are they the third highest producer they have also acquired $5.6 billion worth of lithium assets in countries around the world. China also hosts 60% of the lithium refining capacity for batteries.

Jayamanne: What a novel concept. Australia mining something and China buying it.

LaMonica: Exactly.

Jayamanne: Now lithium is a commodity. There are certain characteristics associated with commodity. What is going to drive prices is supply and demand. If there is more supply than demand than prices generally fall. If demand outstrips supply than prices go up.

LaMonica: And in the short term we have seen prices drop quite significantly. We talked about the high of prices in December. Well since then they have dropped by 45% in just four months. And the reason for this is that the Chinese government stopped subsides for electric vehicles at the end of 2022 and for battery manufacturing. So a big surplus built up in batteries at the end of 2022 and this overproduction is not leading to a bit of a glut.

Jayamanne: One other thing recently happened. 8.5 million tonnes of lithium was found in Iran which increased world reserves by 10%. With these huge price swings in this emerging technology and the inputs into it this is a place where traders have made a lot of money if they played things correctly. But we don’t cater to traders on investing compass. We are interested in if this is a long-term opportunity.

LaMonica: And we will get back to that. But first lets talk a bit about psychology and how that plays out in markets. Hype and an easy to understand narrative always enticing investors. Past performance which includes that incredible price rise leads investors to assume that will happen forever. This has been playing out throughout history. None of the stats that we just listed is not well known to investors.

Jayamanne: And the issue with hype is that dollars follow it and price increases follow it. We’ve seen that with lithium with the huge price increases in the underlying commodity. And we’ve seen that with lithium mining companies which get tons of capital. The first thing that happens is that we see huge increases in production. Even very expensive ways of extracting lithium get funded. They get funded by the huge inflows of capital and those mining operations are justified by the high prices of the commodity. This cycle continues.

LaMonica: The second thing that high prices bring about is the search for substitutes. Battery makers search for substitutes. And this is happening. Everything from seawater to hemp has been suggested as alternatives. Part of the driver here is cost. Part of it is because extracting lithium can be very environmentally damaging as it can take huge amounts of water to mine.

Jayamanne: The other thing with hype is that once something because widely known it is often too late to get in on it. If you invested in lithium in 2015 then you would have done very well. But the market is forward looking. That means that future expectations are baked into security prices. And expectations are high. And we say this a lot on investing compass but the performance of an investment is not so much how it performs on an absolute basis but how that performance in comparison to the hype.

LaMonica: And we can’t say that enough. To generate great returns over the long-term you need to think that future expectations are wrong. That works if you find something where expectations are really low and things don’t turn out to be as bad as suspected. And that works if expectations are really high but things turn out even better than expected.

Jayamanne: And investments that go really poorlywhen the opposite occurs. Things turn out to be worse than expected.

LaMonica: And this is when we can turn to what analysts expectations are for the future prices of lithium. Analyst are supposed to ignore hype and focus on the fundamentals. Now the caveat here is that they are trying to estimate what is happening in the future which is very difficult to do because the future is unpredictable.

Jayamanne: Our own analyst at Morningstar who covers lithium producers is Seth Goldstein. Seth believes lithium prices will average $30k USD per tonne over the next decade. That is below the $47k price per tonne it is currently trading at.

LaMonica: And Goldman Sachs is much more pessimistic. They put out a report saying lithium would fall to $11k USD per tonne by 2024. And the one of the largest battery makers in China named CATL plans to offer its electric vehicle customers a batter price that implies a lithium price of $29k USD per tonne.

Jayamanne: But this isn’t to say that our analyst Seth doesn’t see opportunities. He believes that while prices will average $30k over the next decade. Over the next decade he believes that they will remain well above the marginal cost of producing lithium which he sees at $12k per tonne USD. Which importantly is above Goldman’s estimate.

LaMonica: His top pick which is Lithium Americas Crop with the ticker symbol LAC is trading62% below his fair value estimate which makes it a five star stock.This is a company that is developing mines in South America that are about to start producing one of three major projects in 2023 and production eventually reaching 150k tonnes by the end of the decade.

Jayamanne: The lesson as always is to do your homework. Be careful about the production costs of any miners you invest in. Even if you feel that lithium will resume its climb, a successful investor builds in a margin of safety for any investment. Buying low cost producers will build in that margin of safety. Chasing small cap speculative lithium miners that may have been funded by the hype in the market may not fair well.

LaMonica: As a special offer for anyone who wants to leave us a comment and rating in their podcast app email me at the address in the podcast notes and I will send you our analyst report for Lithium Americas Corp.