http://www.indmin.com/Article/3069761/Its-actually-refractories-that-is-driving-graphite-growth-today.html

Chris Berry tells IM the story behind the graphite boom and what is to come

Graphite has been as sought after as gold in recent times but what exactly has caused the boom and could it be sustainable in the long run? Chris Berry of House Mountain Partners LLC spoke to IM about the boom, what’s next, and how to judge the quality and potential of a graphite deposit.

Can you think what caused the graphite rush in Canada?

It’s hard to pinpoint exactly what ignited the graphite rush and I think it was actually due to a host of factors. As with dozens of metals and minerals, China figures prominently. In the wake of the global recession in 2009, graphite prices spiked due to a slowdown in production from China, which is of course responsible for 80% of global production of the mineral. We've seen graphite prices soften somewhat in recent months and adversely affect the graphite junior exploration space.

Although there were some early movers in graphite junior exploration, something happened mid-December 2011 and the retail investing populace “woke up” and discovered graphite as an investment opportunity.

Since then, graphite has been the focus in a long line of strategic metals or minerals following in the footsteps of uranium, lithium, and rare earth elements. Each of these metals demonstrated the same pattern in terms of a parabolic price rise and ultimate fall. Again, the rush into graphite cannot be pinned on one factor. Control of the market by China, opportunistic promoters, and retail investors looking for the “next big thing” all contributed to increases in graphite share prices.

In my opinion, you need both retail and institutional buy-in to create a sustainable story. Right now, we don't have that with graphite and there is a great deal of money on the sidelines. Until a clearer picture of global growth emerges, I expect this to continue except for a few select "best-of-breed" graphite exploration projects that can prove to the market that they have an economic deposit and the expertise to put it into production.

Are people really interested in the EV story?

People are definitely interested in the electric vehicle (EV) story and EVs are certainly getting a great deal of press. The lithium-ion battery business is thought to be driving graphite demand. Though the li-ion battery business is thought to be growing at 20-30% per year, it's actually refractories, and demand for refractories, that is really driving graphite growth today. Refractories account for the bulk of flake graphite demand (up to 40%).

To date, EV adoption has been slower than many would like, owing to a host of factors including the cost of the battery (really the cost of the entire car), range anxiety, and a lack of infrastructure for charging the battery. Until these and other battery chemistry questions are solved, you can expect to see a lid on widespread commercial EV adoption.

If investing is characterised by two emotions, greed and fear, it's fair to say that greed was a factor in pushing up graphite share prices. That said, there are a host of different avenues of demand for graphite from refractories to steelmaking, pencils, and batteries, as well as other next generation technologies.

I think graphite will continue to be an exciting place to invest as there are hundreds of billions of research and development dollars going into next-generation technologies such as energy storage and fuel cells, which require high purity flake graphite.

I would also caution investors to remember that synthetic graphite is a major factor in the industry and is used in many li-ion batteries today. Although it's expensive to produce, end-users appear willing to pay this premium as synthetic graphite meets their very specific requirements. A producer of natural graphite must prove to potential end-users or offtake partners their quality and purity of natural graphite can match or exceed what can be made synthetically at a lower cost. Security of supply for end-users is a critical issue.

How do people judge merits of a graphite project in Canada?

Geopolitical risks are particularly acute when you start talking about strategic or critical materials. Graphite is no exception. Fortunately, there are numerous graphite deposits throughout the world outside of China in reliable geopolitical jurisdictions. Canada hosts numerous deposits in several provinces and so the question then becomes one of economics and determining whether or not a mine is feasible. It is also important to remember that there are deposits of note in Australia, Europe, and Africa.

The merits of the graphite project differ from gold or other commodities. Many in the mining business maintain that grade is king and while I don't disagree with this, I do not think it's the single most important factor when analysing a graphite deposit. I look for management experience in graphite because I want to know that the company understands how to mine this mineral and then sell it to offtake partners or end-users. Relationships are key when you deal with industrial minerals.

Obviously purity and flake size and distribution of a deposit are important. I have heard this concept called “the footprint”. With different types of graphite (flake, amorphous, and lump) as well as different flake sizes, you essentially have different supply and demand dynamics for each and, as such, different prices that the market will bear. A company must understand its footprint to develop an idea of the economics of the deposit in question. As investors become more educated about graphite, a junior mining company must be able to tell you what the composition of the deposit is and how they anticipate bringing it to market.

One of the biggest challenges facing mining projects today is spiraling cost inflation. This is not specific to graphite but investors must watch this. Generally speaking, I believe that the lowest-cost producer of a product always wins. While low-cost is never a guarantee of success, it gives a mining company the opportunity to optimise their mining process should prices for their commodity fall compressing margins.

Is the graphite market flattening?

Interest in graphite has waned somewhat, although I think this is less specific to the commodity and has to do more with the fact that we’re in the summer doldrums and there is tremendous economic uncertainty across the globe. The threat of a global slowdown appears to be affecting all commodities. The TSX Venture Exchange has declined by over 50% since March 2011, so we've seen broad discounting of junior mining shares.

To get a handle on graphite supply and demand going forward, we need to look at a whole host of factors including energy prices, prices for petroleum coke (a main ingredient in production of synthetic graphite), demand for various types of electric vehicles, and research and development for next-generation technologies.

All of these factors, and more, will influence graphite demand in coming years. This is by no means a complete list of what to focus on when thinking about graphite supply and demand, but just a few of the things that I look at when analysing companies.

That said, as the emerging world strives for a higher quality of life, the need for efficiency and sustainability in terms of how we generate and use electricity will come to the fore painting a positive outlook for flake graphite demand.

The huge run-up we've seen in graphite share prices in recent months was unsustainable. Investors must look at the merits of a junior mining story as well as global macro-economic trends to gauge whether not a company is worthy of investment in this exciting and competitive space.

Could you tell us a little about your Graphite Index and how it has been performing?

I put together the graphite index to demonstrate what happens when investor euphoria overcomes common sense and basic economics. My criteria for acceptance into the index is admittedly loose as I wanted to capture the price action of “legitimate” companies such as Northern Graphite (full disclosure: a family member owns shares) and Flinders Resources as well as “illegitimate” companies that might not have sufficient management expertise or the mineral and market knowledge for graphite but are capitalising on “the next big thing”.

I have tracked the index three ways: equal-weighted, price-weighted, and market-cap weighted. Each chart shows the same trend: a rise starting in mid-December 2011 with an ultimate peak at the end of March 2012. Clearly, the largest companies on a market-cap and price-weighted basis influence the index the most. When I strip those companies out, the price movement flattens. This tells me that the largest or highest priced companies (Northern Graphite, Flinders, Syrah Resources) have a disproportionate influence in the index and have proven to be the most profitable companies to invest in.

Also, to be fair to the companies which comprise the index, some are more advanced than others. Comparing a graphite exploration company with a bankable feasibility study in hand to an exploration company with claims on land prospective for graphite might not be “apples to apples”. Nevertheless, as I said before, I constructed the index to demonstrate price action more than anything else. The sad reality is that there is only room for a small number of graphite companies to enter into the industry and you'll see most of the index constituents either consolidate or die from a lack of funding.

The index consists of 56 publicly traded junior mining companies listed in Canada and Australia which manage a total of 109 different projects. I am also watching seven private graphite plays and will add them to the index if and when they list publicly.

Between 29 July 2011 and 30 July 2012, the equal-weighted index had a return of -21%. However, since 1 January 2012 the index has had a positive return of 22.5%. Both the year-over-year and year-to-date returns significantly outperform the TSX-Venture exchange which has fallen over 19% year-to-date. The price weighted and market-cap weighted returns don’t differ significantly from these results.