Should you bet big on these ASX-listed lithium shares?

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In the late 1990s, a company only needed to mention “dotcom” in its name and its share price would soar. Similarly, Bellamy’s, Blackmores and a2 Milk Company all skyrocketed in 2015 in what proved to be a baby formula boom.

And now it seems lithium miners have become the latest craze. Lithium is an element with many uses, including in smartphones which are mostly powered by lithium-ion batteries.

However, lithium batteries are also widely used in renewable energy which will almost certainly play a big role in our future whereby cars and even homes are expected to be powered by rechargeable batteries.

Of course, Elon Musk’s Tesla is one of the most well-known companies that is driving innovation in that direction, for example see the company’s latest car model, the Model 3, as well as its Powerwall designed to power homes and buildings. Also, there are a number of other businesses vying for a dominant position in those markets, including Mercedes and BMW.

As a result of an expected rise in demand, lithium prices have skyrocketed over the last seven months or so, rising from around US$7,000 a tonne in October to around US$22,000 a tonne in March, according to Thomson Reuters.

Shares across the sector are rising higher again today, but the most notable is Capital Mining Limited (ASX: CMY), whose shares have surged 125% (albeit to 0.9 cents each). The micro-cap explorer announced it had executed a binding Sale and Purchase Agreement to acquire Shaw River Lithium Pty Ltd, which holds 13 prospecting licence applications for the Pilbara region of Western Australia.

Similarly, shares of Prospect Resources Ltd (ASX: PSC) soared 217% on Wednesday to 1.9 cents (they’ve fallen to 1.8 cents today), while Kingston Resources Ltd (ASX: KSN) shares have gained 52% after the company announced a “major lithium portfolio acquisition” this morning, accompanied by a $6.85 million capital raising.

Don’t get sucked in just yet…

While those gains might seem tantalising, Kingston’s venture into the lithium market highlights one of the key risks facing investors.

As prices rise, more and more explorers will venture into the sector in search of lucrative returns, which will increase the market’s supply. When that happens, prices will likely begin to decrease which will wreak havoc for those companies who have either overpaid for acquisitions or maintain higher costs than their competitors.

Another risk is that investors will begin to expect big gains in share prices. Shares of companies such as Prospect Resources and Altura Mining Ltd (ASX: AJM) have gained 280% and 1,500% over the last 12 months, while Dakota Minerals Ltd (ASX: DKO) has also risen 858%.

However, those kind of returns are not sustainable in the long run. They could either slow down or fizzle out altogether, or else experience sharp falls in the event they do not live up to the hype.

To demonstrate the volatility, shares of Dakota have actually fallen 32.1% today, while Altura Mining is also down 4.1%.

Sometimes, shares in certain businesses or entire industries can become so hyped up that investors are only buying based on momentum or on the belief they can sell to another sucker for an even higher price. While it is impossible to know when it will happen, that is certainly a risk facing investors buying into the sector today.

As tempting as it may be, investors would be wise to watch this unfold from the sidelines and focus instead on the many higher-quality businesses that are trading on the ASX.

In this low interest rate environment, a good starting point would be the 3 Best Dividend Buys Now, chosen by our resident dividend guru. Simply click here to learn more about these shares.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Tesla Motors. Motley Fool contributor Ryan Newman owns shares of Bellamy's Australia. The Motley Fool Australia owns shares of Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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