Citi now “doubly bearish” on lithium
Citi is doubling down on its April short trade because the fundamentals for lithium have not improved, and supply cuts are yet to occur.
In April, we reported on a short trade recommendation made by major broker Citi for the CME August 2024 lithium hydroxide futures contract. Citi believed the price could decline from around US$16,700/t at the time to US$10,000/t, a decline of about 40%.
At the time of writing, the August lithium hydroxide futures contract is trading around US$15,450/t delivering those who followed Citi’s recommendation a 7.5% gain in one month. Remember, hedge funds often work in annualised returns when considering trades of a short term nature – so that’s around a 90% return on an annualised basis.
Nice call Citi 👍
Today I bring you news they’re not taking profit on the trade yet, and worse still for lithium bulls, they’re doubling down on their short bet by recommending traders also short the December lithium hydroxide contract.
The main reasons for the new trade are consistent with the original trade. Citi has two main contentions:
- “A reset in global EV sales expectations (particularly in the US and Europe)…In addition to this, the strength in Chinese EV demand is not necessarily translating into lithium price gains”
- “We see the lithium market in a large surplus (~6% of total supply) this year and next. Supply cuts have been limited this year to date and most of the greenfield/brownfield expansions continue to progress increasing volumes.”
Fundamentals “remain weak”, lower prices required
On the first point, Citi points out that the fundamentals for lithium minerals “remain weak on account of looser balances largely driven by our expectation of a softer ex-China EV outlook”. Additionally, a “combination of macro and micro factors has driven slower-than-expected growth in US and European EV sales”, and this means we’re in the midst of “an EV downgrade cycle” and therefore we’re “unlikely to see a major improvement in Western EV demand over the next 6-12 months.”
On the second point, Citi argues the cure for lower lithium minerals prices is ultimately – lower prices. They suggest that at current spot prices, there’s little incentive for miners and converters to cut volumes. Only lower prices can force curtailment, and therefore rebalance the market – “A lower-price environment (sub-US$12,000/t) over the next 6-9 months should be sufficient in our view to drive the market to rebalance”, notes Citi.
Let’s contango!
As for the futures trade itself, there’s also an element of contango at play. This means that the futures contracts are trading at a price that is higher than the spot price. The combination of the erosion of the contango premium, and the bearish market fundamentals, should conspire to yield a profitable short trade.
The December contract is currently trading at US$15,900/t, an 11% premium to the spot month’s contract at US$14,290t. When you add in Citi’s spot prices forecast of US $11,000/t over the next six months, the broker suggests the total expected return on the trade could be as much as US$5,000/t, or around 31%.
Short term bear, long term bull
It’s worth reminding everyone at this point that Citi’s medium to longer term views on lithium are relatively bullish. “We remain constructive on EVs and lithium over the medium term despite weaker near-term sentiment”, they note.
Citi cites the fact China EV sales “remain strong”, but also that the mix is changing with more plug-in variants (PHEVs) being sold than fully electric versions (BEVs). PHEV’s require a smaller battery, and therefore use a smaller amount of lithium per vehicle.
But, in the longer term, Citi believes that new battery technologies such as the Shenxing PLUS lithium iron phosphate (LFP) battery which claims a 1,000 km range, as well as range-extended electric vehicle (EREV) platforms that use generators to recharge a battery, should be able to “overcome the range anxiety issues”. Ultimately, this will lead to a greater adoption of EVs, and therefore greater lithium minerals demand.
It’s just a matter of time…
Like with many major transitions, it will take some time – possibly longer than many lithium bulls initially anticipated. Citi thinks lithium investors need to think really long term, “Beyond 2025, we see the lithium market as largely in balance for 2026 and 2027”, they say. But assuming lower prices can weed out marginal greenfield/brownfield projects and expansions, this “could easily tip the balances into deficit for 2026/27, sending prices higher”.
In keeping with Citi’s lower prices is the cure for lower prices thesis, I’ll leave you with this last quote from their research report:
The industry needs constant investments in mine supply to ensure that the requirements of the energy transition are met. In the event lithium continues to trade at current prices for next 6-12 months, future project supply, especially of junior miners, will inevitably face funding issues as these projects may not be viable at current prices. Most of these projects are expected to bring volumes into the latter part of the decade and failure to achieve financing milestones could eventually impact lithium supply.
This article first appeared on Market Index on Wednesday 22 May 2024.
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Carl has over 30-years investing experience and has helped investors navigate several bull and bear markets over this time. He is a well respected markets commentator who specialises in how the global macro impacts Australian and US equities. Carl has a passion for technical analysis and has taught his unique brand of price-action trend following to thousands of Aussie investors.
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Investing is risky. Inevitably you will endure losses. If you can't cope with losing, don't invest.
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Carl has over 30-years investing experience and has helped investors navigate several bull and bear markets over this time. He is a well respected markets commentator who specialises in how the global macro impacts Australian and US equities. Carl...
Carl has over 30-years investing experience and has helped investors navigate several bull and bear markets over this time. He is a well respected markets commentator who specialises in how the global macro impacts Australian and US equities. Carl...
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