Is this commodity in the midst of an epic price bubble?

Kim Iskyan from Truewealth Publishing, tells us about the (financial) state of lithium…

Lithium might be the energy of the future. And lithium might be in the midst of an epic price bubble. Or, both of these might be true.

Lithium is nature’s lightest solid element, and is one of the most abundant metals in the earth’s crust. Once processed, it can be used in everything from ceramics to grease. It’s even used to treat bipolar disorder. But that’s not why The Economist magazine recently called lithium “the world’s hottest commodity.”

A soft, silver-white metal, lithium can store a huge amount of extractable energy in a small space. It stores twice as much energy as the next-best energy storage material, nickel-cadmium. This makes it one of the best metals to use in rechargeable batteries. If you own a laptop, smartphone or iPad, chances are it uses a lithium-ion battery.

The market for lithium-ion batteries is forecast to grow from US$25 billion a year in 2015 to US$40 billion a year by 2020. That’s partly thanks to the growing number of smartphone users. But the real growth in demand for lithium stems from its central role in electric vehicles (EVs). A smartphone battery only uses a few grams of lithium, but a lithium-ion battery for an electric car uses about 10 kilograms.

For this reason, investment firm Goldman Sachs recently labelled lithium “the new gasoline.” They predict demand for lithium will triple by 2025. Others predict it will at least double.

Tesla Motors gets all the media attention when it comes to electric cars. The company is aiming to sell 500,000 cars a year by 2018, and 1 million a year by 2020. Last year, Tesla CEO Elon Musk said, “In order to produce a half million cars per year… we would basically need to absorb the entire world’s lithium-ion production.”

Traditional automobile companies, including BMW and Audi, are also developing electric cars. Apple and Google are even trying to gain a share of the market and develop their own brands of EVs. Over the next two years, 25 new makes and models of electric cars are expected to be released.

Much of the growth in demand for electric cars is expected to continue to come from China, which already consumes about 20 percent of global lithium production. China’s pollution problem means that it’s looking for ways to use less fossil fuels, like gasoline. China now accounts for 68 percent of the global lithium battery market, and 55 percent of the world’s electric cars – totalling 379,000 – were produced in China.

But the EV market is still tiny. According to a feature in Bloomberg, electric cars only make up one-tenth of one percent of the total car market today. But as the price of lithium-ion batteries falls (it was down 35 percent last year), the price of electric cars will drop as well. That’s because batteries currently make up a third of the cost of electric cars. One forecast calls for 35 percent of all car sales to be electric vehicles by 2040.

An industry group report noted that lithium carbonate (which is the most common lithium compound) was already in short supply in the fourth quarter of 2015, which caused prices to soar. Global lithium carbonate output increased by 12.3 percent to 202,800 tons in 2015, and is forecast to grow by at least 18 percent a year until 2018, the report said.

Even with higher costs for lithium, battery costs will still decline because all the other components that go into making a battery are getting cheaper. And as more batteries are produced, and companies get more efficient at making them, the per unit cost will continue to drop.

But the growth in supply is not expected to match the growing demand. One forecast calls for the world’s lithium demand to be 25 percent higher than supply by 2020.

Lithium, which is mostly recovered from underground deposits of brine and then refined, isn’t traded on an exchange, so its price isn’t as easy to track as most other commodities. As a result, it’s hard to get an accurate idea of what has been happening to lithium prices with this increasing demand.

But industry reports from China suggest that the price of lithium carbonate (the key raw material for lithium production) rose from 40,000 yuan (US$6,150) per tonne at the beginning of 2015, to 100,000 yuan (US$15,350) per tonne by the end of the year. It’s now trading at 130,000 yuan (US$20,000) per tonne. That’s a 225 percent spike in prices in just over a year.

As shown below, that compares to a 6 percent gain in the price of goldand silver, a 10 percent drop in the price of oil and copper prices tumbling 27 percent over the same time period.

Lithium is a great story. It also looks like it’s in the midst of a bubble. Anticipated demand for electric cars has not yet materialised. It’s difficult to predict how quickly consumers will embrace EVs. The development of an EV battery that doesn’t use lithium, or one that uses less, would hurt lithium prices.

And whenever the price of a commodity more than triples in a year, and when magazines and banks trip over each other to anoint an asset “the next big thing,” it’s probably overheated and due for a sharp fall.

If you disagree and think the lithium bubble has further to run, one way to invest is through the Global X Lithium ETF (NYSE; ticker: LIT). Its holdings include several lithium producers, as well as other securities including Tesla Motors and Samsung, which are major lithium battery users. If you’re afraid of sharp share price swings, you might want to avoid this. But if you’re inclined, use a tight stop loss.

Kim Iskyan