Why ASX lithium shares could come under more selling pressure

One of the most volatile areas of the Australian share market is arguably the lithium miner industry.

The shares of the likes of Galaxy Resources Limited (ASX: GXY), Kidman Resources Ltd (ASX: KDR), Orocobre Limited (ASX: ORE), and Pilbara Minerals Ltd (ASX: PLS) will often swing wildly to the upside and downside despite there being no news out of them.

I believe that this is likely to be down to the fact that lithium bulls and lithium bears are fighting it out for control.

The bulls believe that demand for the battery making ingredient will increase quicker than supply in the future due to its usage in electric vehicle batteries. Whereas the bears believe that supply will grow quicker than demand and lead to lithium spot prices crashing.

What will happen?

That’s the million-dollar question. But if a recent research note out of Moody’s is to be believed, the bears may be the victors in this tussle.

According to the note, Moody’s believes that lithium markets will be oversupplied in the early 2020s despite electric vehicle growth.

The report states: “Lithium markets will be oversupplied, particularly in the 2020-2022 time period when we expect a heavy concentration of new mine and conversion start-ups, even with obstacles to new supply and assuming a 30%-40% haircut to announced capacity.”

One positive, though, is that Moody’s believes the impact of lower spot prices will be minimal for major lithium producers such as Albemarle and FMC. This is because these lithium giants tend to have “long-term contracts with minimum prices and other protective terms that mitigate low spot prices and protect margins.”

What will the lithium market look like in a few years?

Moody’s expects the structure of the lithium industry to shift over the next decade.

It expects the market to go from a few major miners producing “battery grade lithium from low cost brine in Chile and Argentina and low cost ore from the Greenbushes rock mine in Australia, to a more diverse industry structure with new rock-based entrants mining ore in Australia and selling spodumene to Chinese converters, as well as new rock and brine-based suppliers in Brazil, Canada and the US.”

What now?

Where the lithium market goes in the next few years, only time will tell. However, I do think at current levels Galaxy Resources’ shares offer a compelling risk/reward. Not only does the company have long-term offtake agreements and is generating strong free cash flow, the recent sale of tenements means it is cashed up.

However, as I said at the beginning, the lithium miners are highly volatile and thus largely unsuitable for the average investor.

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Motley Fool contributor James Mickleboro owns shares of Galaxy Resources Limited. The Motley Fool Australia has no position in any of the stocks mentioned. 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 Scott Phillips.

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