Lithium Investing in a Season of Volatility, Economic Uncertainty and Oversupply Fears

Lithium prices rally, oversupply fears hit the market

Lithium is a key raw material used in the batteries that power electric vehicles (EVs), and the EV industry is the commodity's main demand driver. However, just a few years ago, the EV narrative had yet to materialize, with most discussions around the need for lithium focusing on expectations for future EV sales.

Back in 2018, lithium prices were in a downtrend, and they stayed at low levels for a couple years as an increase in supply hit the space and EV growth slowed. This was following the run that lithium had in 2016 and 2017.

Fast forward to late 2020, half a year after the onset of one of the COVID-19 pandemic, and lithium prices had taken a turn because adoption of EVs had started to rise.

Just last year, EV sales reached 6.6 million globally, with lithium demand increasing as a result. Prices for every lithium product climbed, touching all-time highs as investments poured into the sector.

“Never in my wildest dreams would I have thought we would see US$70,000 (per metric ton) spot lithium prices, so I'm very happy to see it. I think there are a number of reasons behind it, whether or not it's speculation, stockpiling and, of course, just outrageous demand in China,” Chris Berry of House Mountain Partners said.

“But I don't have much of a feeling for if we go to US$100,000, or wherever we go," he said. "I'm just a lot more focused on when this cycle gets a little bit long in the tooth, and when we mean revert, where do we land?”

Lithium prices have remained at historical highs so far in 2022, even though they have started to stabilize. Furthermore, this year lithium producers have seen their profits rise, and they have increased their guidance for the year ahead; juniors are also receiving offers for production that is yet to see the light of day. Expansion plans once put on hold are back on track, with project announcements and restarts being pushed forward.

But following months of optimism about lithium and stocks seeing gains, in June, investment bank Goldman Sachs (NYSE:GS) published a report saying that the bull market for battery metals is over for now. Analysts at the firm are predicting that prices for lithium will drop in the next two years, with a “sharp correction” happening by 2023.

"(There’s been) a surge in investor capital into supply investment tied to the long term electric vehicle (EV) demand story, essentially trading a spot driven commodity as a forward-looking equity,” Goldman Sachs analysts said. “That fundamental mispricing has in turn generated an outsized supply response well ahead of the demand trend.”

It took little time for lithium experts and analysts to call out Goldman Sachs, with many, including major lithium producers, disagreeing with the bank’s forecast.

Daniel Jimenez of iLi Markets told the Investing News Network (INN) that analysts at the investment bank are overestimating supply and underestimating demand.

“On the supply side they are extremely optimistic in terms of the lepidolite production that could come from China in the coming years, which is also not realistic,” Jimenez said. “Bottom line — we believe it will be just the contrary.”

Speaking with INN about the lithium space in late June, Joe Lowry of Global Lithium highlighted the fact that it can take two years to build a gigafactory, but it takes up to 10 years or more to bring on a greenfield lithium project.

“You couple that with the fact that now demand is growing each year more than the whole market was in 2016. That's a huge difference,” he said.

For the expert, another key factor to remember is that, despite current high lithium levels, prices don’t solve all the challenges the industry faces to bring on supply into the market. “High prices don't increase the talent pool, high prices don't change the permitting rules in various countries where projects are happening,” Lowry pointed out.

For William Adams, head of base and battery metals research at Fastmarkets, it's also important to remember that when new supply comes online, each of those new production lines needs to be qualified.

“So that means that a lot of potential consumers won't take that material until they see that new production line running a steady state. And once they've got that, then they'll take samples and get that qualified,” he told INN.

So are the lithium oversupply fears justified?

“In the immediate future, we're in a situation where there just aren't enough units out there,” Jon Hykawy of Stormcrow Capital told INN. “We're not producing enough lithium to satisfy the latent demand.”

But for Ken Hoffman of McKinsey, this might not remain the case in a long-term basis.

“Despite the fact of such amazingly high prices today, I would be concerned that there could be periods in time in the future, and I can almost guarantee, of oversupply. It's just the way the industry works,” he told INN.

“One thing we tell clients is make sure you're integrated into this industry, make sure that if you're going to build a lithium facility, you have a customer that you're integrated to.”

Investing in lithium when uncertainty is high

Oversupply worries are not the only factor impacting lithium stocks, with concerns over inflation and the future of the economy currently top of mind for investors.

With recession fears soaring, there are concerns that consumers might rethink their vehicle purchasing options, or even push off their adoption of plug-in hybrids or battery EVs for a period of time.

“But you've seen what gasoline prices have done. So there's a countertrend,” Hykawy said. “We're going to be back to a point where we're having pretty much unrestricted discussions about adoption of these vehicles and the like.”

Looking at how the overall stock market is performing today, he said investors should keep in mind that it runs in cycles. “The old adage is the stock market can remain irrational much longer than you can remain solvent — that's never going to go away,” Hykawy noted. “The fact of the matter is I'm encouraged more by the continued optimism and the directionality that the automotive OEMs are putting on this space, and the continued emphasis on growth that is reflected by the majors in the lithium market at this point.”

For the expert, optimism is warranted at this point. “The stock market eventually will get over whatever it's getting over and it will come back," he said.

When looking at how to invest in lithium given the overall market conditions, it's important for investors to consider their timeframe. An investor who is thinking quarter to quarter is different from one with a longer-term perspective — to the end of 2023, for example.

“I think right now you're pretty cautious,” Berry told INN back in late June. “If you take a step back and say, 'Okay, well let's think about how big this industry is going to be in 2025 or 2030,' volatility right now just doesn't hold the same weight in terms of concerns. So that's how I tend to look at these markets.”

Considering the supply challenges the industry has faced to bring new production online and where demand is going, Berry remains optimistic about the long-term outlook for lithium. “I would expect to see, under the best of circumstances, very tight markets for a lot of the battery metals, and no oversupply for the next few years, at least. So I don't see any reason why you wouldn't maintain that bullish kind of long-term view,” he said.

For investors interested in lithium stocks, Hykawy suggested looking into projects that can produce at a profit with a reasonable long-term cost of lithium. “That long-term cost of lithium is probably looking like US$15,000 a tonne, maybe not US$70,000. But US$15,000 to US$20,000 is probably a reasonable conservative to pessimistic level to examine whether a project is profitable,” he said.

“That's the place that you're looking for, and there are a large number of projects that can do that. It's really a matter of finding the ones that are furthest down the development chain and bringing those to production.”

For Hykawy, if investors can find a solid lithium brine project, it's probably a worthwhile investment.

“But I would counsel any group, including financial investors, that are interested in producing lithium to a timescale ⁠— rather than just an open-ended, need-to-be in this space ⁠— I would counsel them to be looking at hard-rock projects instead,” he said. “Because, yes, maybe your recoveries are not great. Yes, maybe your costs are higher than you thought. But at least you'd be producing units, and with a brine, that isn't guaranteed.”