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There are more than 50 ASX stocks with exposure to cobalt. Terra Capital portfolio manager Matthew Langsford explains what to look for when investing in the popular battery metal.

Cobalt stocks have been a strong investment over the past year because of demand from electric car battery makers. But some have lost value in recent months. What is the outlook?

Many Cobalt juniors have stagnated despite the very strong performance of the underlying commodity, but I think this presents more of a buying opportunity than a need to exit the theme.

There are concerns that cobalt could be substituted out of batteries, but the simple fact is that if you increase the nickel proportion (and reduce the cobalt), you reduce the stability of the battery and so it has an impact on cycle life, the ability to charge it fast and battery safety.

You only have to imagine the impact a battery-related fatality would have on this nascent industry to understand how unlikely it is that a vehicle manufacturer would risk safety for a relatively small saving.

LG Chem and SK Innovation have announced plans to produce 811 NCM batteries but no 811 batteries are in commercial use and experts don’t expect commercial use of 811 batteries to occur before 2023 at the earliest.

Supply constraints have been a contributor to the strength of cobalt’s price but with so many explorers joining the market, will that continue?

Even without electric vehicle (EV) demand, cobalt is a tight market. Add the expected EV demand into the mix — where we model 5 per cent penetration in 2025 — and we have a major problem.

The key concern is that supply out of the Democratic Republic of Congo (DRC) will ramp up and satisfy demand. Yes, the DRC miners are ramping up supply but the market is already tight without factoring in EV penetration.

The instability of the government in the DRC add a significant amount of risk. Protests against long-standing president Joseph Kabila have intensified in recent times and elections are now overdue.

We do not assume any major issues in our modelling, but the concentrated nature of the cobalt supply side means the potential for a supply shock remains high.

Lax laws around child labour and untraceable artisanal cobalt are issues end users want and need to distance themselves from.

Outside of that region, advanced projects are limited. Many of the more advanced Australian projects (ASX:CLQ, ASX:AUZ, ASX:ARL) have very high capital expenditure as a result of being laterite deposits. Commissioning of laterite ore processing routes is notorious for cost and time overruns meaning it’s hard to put them into a supply schedule for at least 5 years.

This reaffirms our belief that in the short to medium term, there will continue to be a strong reliance on Cobalt produced within the DRC.

However, these assets are still predominantly tied to copper production. For DRC copper to fill the void of a doubling in Cobalt demand for lithium batteries in 2025, based on current cobalt by-product grades from DRC copper deposits, copper production would need to more than double from 1.0MM to 2.66MM t by 2025 according to CRU.

A spike in copper production alone would provide cobalt, but we view this scenario as highly unlikely. In Q1/16, DRC Co production dropped by 20% as a reaction to falling copper prices.

Is demand for electric vehicles, and in turn cobalt, really as high as cobalt bulls have made out?

Even if you completely discount consumer-driven demand, Government mandated EV adoption alone underpins a rapid increase in demand, led by China.

The Chinese government has committed to a build out of nationwide charging infrastructure to 5 million new energy vehicles (NEVs) by 2020 and initiated a credit system to encourage auto manufacturers to target NEV production percentages of 8%, 10% and 12% over the next 3 years.

In Shanghai, licensing laws are highly prohibitive for ownership of conventional cars, restrictions which do not exist when it comes to NEVs.

Looking globally and similar initiatives have been implemented across the EU, USA and Japan.

In addition, demand predictions don’t appreciate the fact that many of the world’s largest battery manufacturers including CATL, LG Chem and Samsung see Energy Storage Systems for home and business as being a far bigger market compared to EVs and currently none of the investment banks are factoring in these numbers into their demand models.

What do you look out for in cobalt stocks?

High quality management – In our opinion, this is the key to investing in small caps. Take a look at whether the management have been involved in listed company success in the past, whether a takeover/significant re-rating. If they were in a listed company that did well, were they one of the individuals that was instrumental in that company’s success?

Low capex/simple processing routes – this typically means we prefer sulphide deposits over laterite ores as laterites are notoriously difficult and expensive to process.

Grade and primary cobalt – Higher grade is preferable and ideally a primary Cobalt deposit – this means the deposit’s economics will not rely on the price of commodities other than Cobalt.

Location – sovereign risk is a significant consideration when it comes to cobalt. We prefer a first world location – or at least not the Democratic Republic of Congo.

Which ASX cobalt stocks are you watching?

First Cobalt Corp (ASX:FCC) – High quality management, first world asset location (Canada and USA), sulphide deposit, they own a permitted refinery (one of the only refineries able to process the high arsenic ores present in the Ontario cobalt belt ores).

Jervois Mining (ASX:JRV) – Experienced management (Xstrata metal sales), first world asset location, not sulphide but they’re not proposing a complex or expensive processing route

Collerina Cobalt (ASX:CLL) – High quality management, first world asset location, not sulphide but have a proprietary processing route that is low capex

Blackstone Minerals (ASX:BSX) – Early stage but it has first world asset location and very high-grade sulphide hits.

Terra Capital holds interests in First Cobalt, Jervois Mining and Collerina Cobalt

Matthew Langsford is a portfolio manager at boutique investment manager Terra Capital. Matt is a qualified Chartered Accountant and has worked in corporate finance at Ernst and Young and in institutional and high net worth broking, specialising in small caps.

Terra Capital is a specialist investment manager with a proven track record of performance, a focus on risk management and with a management team that is strongly aligned with investors. Terra Capital launched the Natural Resource Fund in 2010 and Ethical Emerging Companies Fund in January 2016. Both Funds remain open to investment.

More information: www.terracapital.com.au

This article does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.

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