Why yesterday's lithium crash doesn't mean the price party's over

Australian lithium producers fall Tuesday despite record prices
Fall likely the result of profit taking
Lithium demand still strong

The rise in the spot price of battery-grade lithium carbonate to a record high of 605,000 yuan ($128,000) in China seems tailor-made to drive more gains in the stock prices of Australian lithium producers.

However, any investors hoping for that response were left disappointed yesterday when practically all of the bigger players closed in the red. Quite deeply in the red, actually.

Allkem (ASX:AKE) and Core Lithium (ASX:CXO) both saw loses of more than 10% while others like Pilbara Minerals (ASX:PLS), Liontown Resources (ASX:LTR), Lake Resources (ASX:LKE) and Mineral Resources (ASX:MIN) also fell substantially.

This seeming paradox may have lithium market watchers and investors scratching their heads but while some sources have indicated the potential for a sharp fall in prices next year, yesterday’s retreat is likely to be due to a spot of profit taking.

Analysts polled by Stockhead certainly agree with the sentiment.

Capital markets veteran Peter Strachan is not convinced by forecasts from major broking houses predicting a lithium surplus in a couple of years. He believes the falls were probably due to “prudent profit taking … taking place in a market that has gone crazy from a valuation standpoint”.

This contrasts with Goldman Sachs’ forecast earlier this month that the lithium market will swing into surplus when the Chinese EV market moves towards a demand-constrained state over the next one-to-two years.

VP Capital co-founder and portfolio manager John So disputes that. He reckons EV demand will rocket over the next six months as China relaxes its hardline COVID-19 Zero Policy which has put cities under full or partial lock downs.

“The current electric vehicle market demand for lithium that is most principally driving these high spot prices is off the back of a half functioning Chinese economy that is not in full operational mode,” So says.

“But we are now seeing these rules relax, China is reducing quarantine rules for international arrivals, and I think over the next six months we are going to see the biggest electric vehicle market, which is China, open-up and to the extent the economy is nowhere near as bad what people expect– the electric vehicle demand is going to be even higher than expected.

“Right now the demand we are seeing is with a handicap China and a lot of that hasn’t been taken into account.”

Likewise, Minelife founding director Gavin Wendt believes the sector-wide pullback in the lithium space is entirely related to profit taking, as investors look to cash in some of their recent strong gains.

“Lithium as a commodity has really outperformed, and so have lithium equities, particularly when you compare them to the performance of the rest of the resource sector over the course of this year,” he told Stockhead.

“We might also be starting to see some switching from lithium equities, where a lot of the upside might already be priced in, to other sectors – such as base metals and iron ore, which have underperformed lately, but are starting to re-emerge due to the potential for an easing of Chinese Covid restrictions.

Taking a lead from the US

So also pointed to Australian lithium stocks taking their lead from the US (as usual), where lithium stocks performed relatively weakly compared to the rest of the market on Monday.

“I think some of the bearish notes coming out from places like Macquarie also had some impact, although it is not the first time that we have seen an investment bank or broker make these types of predictions about lithium,” he added.

“The market has become a little more used to these countercyclical predictions, and more generally, I think the drop in share prices yesterday is less fundamentally driven and more profit-taking market-driven.”

So pointed out that most of the stocks that traded down 10-15% yesterday were also up strong the previous day, while others – like Core Lithium and Liontown Resources – are still up for the month.

“People are trying to call the top because the lithium spot price has run very hard, and some of the more experienced analysts – who have seen many cycles in commodities – have become more comfortable with trying to call the top. So I am not surprised to see the stocks trading down every now and then,” he added.

“I don’t see any major catalyst for the lithium spot prices to come down in the next little while, because there is no major supply coming on, demand is only increasing, especially with China moving towards less stringent COVID 19 rules.”

He also highlighted previous instances when investment banks published bearish notes on lithium, which saw stocks close slightly down or flat by the end of the day before bouncing back.

Lithium prices still strong

Despite its expectation that prices will slip in the longer term, Goldman Sachs still believes that lithium prices will remain high in the near-term due to stimulus-led restocking and higher than expected electric vehicle sales in China.

Meanwhile, the Security Times Network quoted Zhongyuan Securities as saying that China was still in the peak period of battery installation and that demand for lithium remained strong.

JP Morgan adds that Chinese battery manufacturer CATL’s move to cut production in November is due entirely to an anticipated season reduction in EV sales during the first quarter of 2023.

Battery production often falls late in the year ahead of weaker vehicle sales in January and February in the Lunar New Year season.

Prices might only really slip in 2024 with Gaogong Lithium chairman Zhang Xiaofei predicting that lithium carbonate pricing would drop below 400,000 yuan/t.