Are Lithium Stocks Due, Again, to Catch Up with Oil Prices?

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1 AUGUST 20, 2012 Are Lithium Stocks Due, Again, to Catch Up with Oil Prices? EVENT: LITHIUM STOCKS HAVE EXPERIENCED BREAK-OUTS ALONG WITH OIL IN THE PAST This note revisits the historical patterns that we highlighted in our January 2012 research note that focused on lithium commodity and equity short-term price moves versus that of oil price performance. With the price of oil again experiencing a strong uptick, a 20%+ gain since just mid-june, this note highlights the possibility of near-term break-out in lithium stocks. Following our Jan 9 note, the 4 lithium stocks under our universe have experienced an average 20% jump over a 6 week period. IMPACT: BREAK-OUT IN OIL PRICE SUGGESTS LITHIUM STOCKS SHOULD BE ON RADAR SCREEN As shown in the figure on the bottom left below, the price of oil has historically acted as a leading indicator for lithium carbonate prices, and the correlation over the past decade has been nearly 90%. Considering the very recent break-out in oil prices, to close to $100/barrel for WTI from under $80 in mid-june, we are perhaps not surprised to observe that recent lithium data price trends have also been favourable, with carbonate prices increasing roughly 20% over the past year. What is interesting from the stock perspective is that the recent breakout in the oil price that began in mid-june has yet to be accompanied by a commensurate rise in the lithium stocks. From an equity investor s perspective, we believe this highlights an opportunity to go long quality lithium stocks. The chart to the bottom right shows that the break-out in oil price in late 2011/early 2012 (red ticked line) was indeed following a strong lagged impact in an index of lithium resource stocks that we have created. Following the most recent 20% surge in the oil price, this same lithium index has not broken out. We feel it is appropriate to once again flag these seemingly historic relationships, as investors may be well served to revisit the lithium sector and zero in on the best lithium projects and stocks. Figures 1 and 2. Lithium Carbonate Prices and Lithium Equity Prices versus the Oil Price Change in Oil and Lithium Carbonate Prices Change In Oil Prices Versus Average Change in Share Prices Of Junior Lithium Companies Indexed to 2002 Prices Lithium Oil /1/ /10/ /19/2008 2/27/2009 5/8/2009 7/17/2009 9/25/ /4/2009 2/12/2010 4/23/2010 7/2/2010 9/10/ /19/2010 1/28/2011 4/8/2011 6/17/2011 8/26/ /4/2011 1/9/2012 3/19/2012 Junior Mining Companies (RHS) LAC CLQ NMX Oil 5/28/2012 8/7/2012 Source: Mackie Research Estimates Investment strategy: A historical analysis on prices shows that oil prices have lead significant moves in lithium stocks. We believe there is an attractive alpha-generating opportunity available to investors by going long certain quality lithium stocks. Therefore, we reiterate our SPEC. BUY recommendations on the three remaining lithium companies that we cover: Lithium Americas (LAC), Canada Lithium (CLQ), and Nemaska Lithium (NMX). They may be all characterized as best in breed as are developing quality brine and hard rock projects that are either low cost or allow speed to market. Matt Gowing, CFA , mgowing@mackieresearch.com Raveel Afzaal, Associate , rafzaal@mackieresearch.com This report has been created by Analysts that are employed by Mackie Research Capital Corporation, a Canadian Investment Dealer. For further disclosures, please see last page of this report.

2 The MORNING CALL Industry Update Page 2 OIL PRICES AND LITHIUM STOCKS The relationship between lithium and oil: Aside from general coincident variables driving the strength of the two (ie. GDP growth and industrial production), an important reason that may account for the seemingly tandem relationship between oil and lithium carbonate prices is the new phenomenon of electric vehicles (EV) and electricity storage applications. These technologies seem to gain more attention when energy prices rise. We believe that gaining exposure to lithium is an attractive way to not only get exposure to an expected secular increase in energy prices, but also to gain exposure to the themes of vehicle electrification and electricity storage. We have compared the historical prices (2002 to 2011) of lithium carbonate and crude oil, and found that there is a strong correlation between the price movements of the two commodities. We expect this correlation to grow stronger as more and more lithium is used for energy uses (i.e. in batteries). This linked relationship between lithium and oil prices is shown in the graph below. Figure 3. Lithium Carbonate Prices Have Lagged Oil Prices Change in Oil and Lithium Carbonate Prices 4 Indexed to 2002 Prices Lithium Oil Source: Mackie Research, Bloomberg We see two main reasons to suggest why lithium prices have historically experienced strong upside moves following strength in oil prices: Economic co-dependency: Like oil, lithium carbonate and the other compounds and forms such as hydroxide and lithium metal experience higher demand from end users during periods of strong economic activity (ie. growth in GDP and Industrial Production). The current global economic situation being as challenged and cloudy as it is, there clearly must be something more at play pushing prices higher. Aside from speculation of fiscal stimulus from central banks, the supply side is clearly an issue. We do not cover the oil & gas sector, but in following the lithium space, it is apparent that lithium industry supply is constrained, and not currently sufficient to meet growing demand. Recent supply stocks (ie. FMC s 2011 plant outage at Salar De Hombre) and the coincident spike in prices is a good illustration of the lack of supply buffer available to meet strong demand. Substitution effect away from petroleum fuels to alternatives in high oil price environments: Material increases in oil prices can have a significant impact on consumers. As oil prices rise, many of these consumers will be looking for alternatives to reduce reliance on fossil fuels, and the vulnerability to profits as a result of increasing energy prices. Vehicle electrification and electricity storage applications are markets that will continue to experience higher demand when energy prices rise. Both of these important applications are heavily reliant on lithium.

3 The MORNING CALL Industry Update Page 3 RECENT INDUSTRY DATA POINTS SUGGEST CONTINUED OF STRONG MOMENTUM FOR LI PRICING As recently as August 5, 2012, Galaxy Resources Limited (GXY-AXY, not rated) had a press release that focused on the strong lithium price increases that were being passed through to customers. The comments in Galaxy s press release underscore our investment thesis for the sector: Prices for both technical and battery grade lithium carbonate in China have risen significantly on the back of tight demand and supply fundamentals, with current prices up almost 17% on the same time last year and, the price increases in China follow the increases in global lithium product prices, including lithium carbonate, announced by major producers Rockwood Lithium and FMC Lithium this year. Figure 4. Lithium Carbonate Pricing in China, last 12 months Source: Asia Metal Limited, Galaxy Resources The figure above is also a reflection of the direction and order of magnitude for global lithium prices. Several high profile pricing announcements have been made by the industry s largest producers: Rockwood Lithium announced in early May 2012 to lift global lithium salts prices by 22% or US$1,000 per metric tonne, effective 1 July FMC Lithium announced a price increase of 20% on 23 June 2011 and then another increase of US$1,000/tonne on 18 June Talison Lithium (spodumene supplier) announced a spodumene price increase of 15% in December 2011 and a further 10% increase on 12 July A FOCUSED LOOK AT THE LITHIUM RESOURCE DEVELOPERS AND OIL PRICES We have created a custom index of lithium resource companies (the blue dotted line shown in the graph below), and compare it to the historical progression of oil prices (the red marked line). There are few lithium mining companies with substantially long trading histories, however, we were able to construct an average of 6 of these companies dating back to August, A leading, and seemingly causal, relationship to the price of oil holds for this group of stocks. Following swings to the upside in oil prices, the stock prices of the group of lithium miners generally experience a sharp uptick lagged move to the upside. To be sure, the lithium share price moves are not always sustained, and positions should be monitored. Therefore, the opportunity exists for the risk tolerant investor to go long the best lithium mining companies and profit from the convergence of performances of the stock prices of these companies to the price of oil. So how did this strategy perform in early 2012?

4 The MORNING CALL Industry Update Page 4 Following our January 9, 2012 research note on this topic, the share prices of Lithium Americas (SPEC BUY, $2.30 target), Canada Lithium (SPEC BUY, $0.73 target), and Nemaska Lithium Inc. (SPEC BUY, $1.00 target) rose to highs of 12%, 5%, and 47%, respectively over the 6 week subsequent period. These share price performance followed a 38% rise in the price of WTI oil that was achieved over the August to December 2011 period. The Figure below shows the lithium price index moving in tandem in prior periods as well. Therefore, with the price of oil rising over 20% over the past two months, but with the three aforementioned shares rising only 14% over this period, we think now is a good opportunity to establish or add to positions in these stocks. Despite all of these companies achieving development progress on their respective projects since our January 2012 sector initiating coverage report, these stocks are either modestly higher, or even slightly down in the case of Nemaska and Lithium Americas. Figure 5. Lithium Mining Share Price Gains Have Lagged Oil Price Gains Change In Oil Prices Versus Average Change in Share Prices Of Junior Lithium Companies /1/ /10/ /19/2008 2/27/2009 5/8/2009 7/17/2009 9/25/ /4/2009 2/12/2010 4/23/2010 7/2/2010 9/10/ /19/2010 1/28/2011 4/8/2011 6/17/2011 8/26/ /4/2011 1/9/2012 3/19/2012 5/28/2012 8/7/2012 Junior Mining Companies (RHS) LAC CLQ NMX Oil Source: Mackie Research Estimates HOW TO PLAY THE LITHIUM SPACE: PICK BEST IN BREED HARD ROCK AND BRINE PROJECTS Strategy take advantage of past share price performance: On inspection, not only is there a clear relationship between the price of oil and these lithium stocks, but it also appears that the price of oil leads the performance of these stocks. What is interesting from the stock perspective is that the recent breakout in the oil price that began in mid June 2012 has yet to be accompanied by a commensurate rise in the lithium stocks. From an equity investor s perspective, we believe this highlights an opportunity to go long quality lithium stocks. Solid stock picks to gain exposure to lithium: Identifying projects that provide exposure to rising oil prices and have strong prospects of becoming leading lithium suppliers in attractive end-markets should prove to be a highly profitable investment strategy. In our recently published initiating coverage report, we launched on the following 4 lithium mining companies with a view that they are significantly undervalued: Lithium Americas Corp. (LAC-TSX, SPECULATIVE BUY, $3.10 target), Canada Lithium Corp. (CLQ-TSX, SPECULATIVE BUY, $1.00 target), and Nemaska Lithium Inc. (NMX-TSXV, SPECULATIVE BUY, $1.00 target). Canada Lithium and Nemaska Lithium both own highly attractive hard rock lithium projects, and are at the forefront in terms of commissioning the next new lithium projects. Canada Lithium and Nemaska Lithium offer lower project risk due to the focus on Quebec, a well-known mining friendly district, and also have considerably lower capex requirements. Investors looking for earlier production and cash flow should focus on the Quebec hard rock plays. Those looking for more profitable, farther out cash flows, albeit with greater initial capex, may find certain brine plays such Lithium Americas as particularly

5 The MORNING CALL Industry Update Page 5 appealing. Lithium Americas is developing its flagship Cauchari-Olaroz project, one of the world s most attractive lithiumpotash brine projects. Once built, LAC will be one of the largest and lowest-cost lithium producers in the world. All three companies are expected to produce lithium at considerably high profit margins within the next few years. We suggest owning a basket of all these names as a strategy to obtain premium exposure to expected growth in the lithium sector. All these companies are trading at attractive valuations that are not fully reflective of the expected growth.

6 The MORNING CALL Industry Update Page 6 RISKS TO TARGET Risks include lithium price cyclicality, possible technological substitution away from lithium, and actions by certain governments that impact the lithium marketplace. Exploration, mining and development risks apply to mining companies. RELEVANT DISCLOSURES APPLICABLE TO: CANADA LITHIUM CORP. 1. Matt Gowing visited the operations of Canada Lithium Corp. on November 29, A chartered flight from Toronto to Val D Or, Quebec, and all transportation costs to the site were paid for by Canada Lithium Corp. 2. Within the last 3 years, MRCC has managed or co-managed an offering of securities by the subject issuer. 3. Within the last 3 years, MRCC has received compensation for investment banking and related services from the subject issuer. RELEVANT DISCLOSURES APPLICABLE TO: LITHIUM AMERICAS CORP. 1. In January 2012, Matt Gowing visited Lithium Americas Cauchari-Olaroz site. All reasonable expenses for the trip were paid by Mackie Research Capital Corporation. RELEVANT DISCLOSURES APPLICABLE TO: NEMASKA LITHIUM INC. 1. On Thursday, June 14, Matt Gowing attended a site tour hosted by Nemaska Lithium. Transportation costs including a chartered flight from Toronto to the site were paid for by Nemaska. ANALYST CERTIFICATION Each analyst of Mackie Research Capital Corporation whose name appears in this report hereby certifies that (i) the recommendations and opinions expressed in this research report accurately reflect the analyst s personal views and (ii) no part of the research analyst s compensation was or will be directly or indirectly related to the specific conclusions or recommendations expressed in this research report. Information about Mackie Research Capital Corporation s Rating System, the distribution of our research to clients and the percentage of recommendations which are in each of our rating categories is available on our web site at The information contained in this report has been drawn from sources believed to be reliable but its accuracy or completeness is not guaranteed, nor in providing it does Mackie Research Capital Corporation assume any responsibility or liability. Mackie Research Capital Corporation, its directors, officers and other employees may, from time to time, have positions in the securities mentioned herein. Contents of this report cannot be reproduced in whole or in part without the express permission of Mackie Research Capital Corporation. (US Institutional Clients - Mackie Research USA Inc., a wholly owned subsidiary of Mackie Research Capital Corporation, accepts responsibility for the contents of this report subject to the terms and limitations set out above. US firms or institutions receiving this report should effect transactions in securities discussed in the report through Mackie Research USA Inc., a Broker-Dealer registered with the Financial Industry Regulatory Authority (FINRA)). Toronto Montreal Vancouver Calgary Regina St. Albert