Are Lithium Stocks at Rock Bottom?

The metal used to make electric-vehicle batteries has given investors whiplash. Prices rose rapidly in 2021 and 2022 before falling even faster in 2023. Seaborne spot supplies of the benchmark compounds, lithium carbonate and lithium hydroxide, now cost roughly what they did in mid-2021, according to data from the price-reporting agency Fastmarkets.

Investors can’t bet on lithium itself because the futures market remains undeveloped. Instead they typically buy shares in chemical suppliers with their own resources, such as U.S.-based Albemarle, or lithium-ore miners, often from Australia. Albemarle stock has fallen roughly 60% from its peak, back to levels last seen in late 2020.

A recovery isn’t yet in sight, but one will have to come eventually. Lithium prices are now too low to justify a chunk of today’s ore extraction in Australia and China, let alone investment in new production necessary to feed expected growth in the EV market. That is setting up the conditions for a shortage and rally.

This classic boom-bust story has played out before in lithium. A previous wave of excitement about electric vehicles triggered growth in prices and supply too early, leading to a correction and investment downturn in 2018. When Tesla accelerated EV production in 2020 and battery companies started ordering more lithium chemicals, a scramble for scarce materials sent prices through the roof.

But the rally brought unexpected new sources of lithium supply to light, notably in places such as Africa and China where investors have limited information on mining. That triggered today’s bear market, which has been prolonged by slower-than-expected EV orders and a complex supply chain that accumulates inventories at every stage. Typically, Australian miners sell to Chinese processors, who sell to companies that make cathode active materials, who sell to battery manufacturers, who sell to the likes of Tesla.

The cycle will reset when battery companies and their suppliers start ordering lithium chemicals again. The industry spent last year drawing down inventories, and it may still have some: Albemarle said in an earnings call last week that there was probably a “couple of months’ excess" in the system at the end of 2023. China dominates the supply chain, obscuring the picture.

Meanwhile, EV growth has slowed but not by much. In China, which is by far the largest market, 25% of all passenger-vehicle sales were EVs in the fourth quarter, up from 24% in the third quarter, according to data provider EV-volumes. Sales of plug-in hybrids, which have much smaller batteries that also require lithium, have accelerated globally. The long-term picture remains that the world will need a lot more of the metal than is currently mined.

The safe way to invest is to favor established players with low-cost operations and cash-rich balance sheets that can survive the industry shakeout.

Albemarle is the largest lithium player, but it also has significant debt. Long-term supply agreements stopped it from getting as large a cash windfall as might have been expected during the boom years. If today’s low prices continue throughout this year, it wouldn’t generate enough profit to hit its long-term leverage-ratio target, based on guidance given last week.

But it could have been much worse: Last October, Albemarle pulled out of a deal to acquire a cash-strapped Australian miner, Liontown Resources, for the equivalent of roughly $4.3 billion. Liontown’s market value is now less than $2 billion.

Pilbara Minerals, a more mature Australian miner, might deserve the title of strongest lithium supplier. It has little debt and roughly $1.4 billion of cash on its books after a profitable final quarter of 2023. It hasn’t deviated from a plan to increase output to feed the growth of EVs.

This also limits the opportunity for investors: Pilbara’s stock is down only about a quarter from its peak. But lithium is volatile, both as a metal and as a commodity market. Investors might not benefit from adding risk at the company level too.

Write to Stephen Wilmot at stephen.wilmot@wsj.com