Why SQM, Standard Lithium, and Piedmont Lithium Stocks All Dropped Today

The bull run on lithium stocks seems to have run its course.

Last week, lithium stocks exploded higher after British mining giant Rio Tinto Group (NYSE: RIO) announced it was buying Arcadium Lithium (NYSE: ALTM) for $6.7 billion, a move that seemed to signal that the cyclical lithium market has hit bottom and is ready to bounce back. Shares of lithium companies entirely unrelated to that specific transaction also surged, with Piedmont Lithium (NASDAQ: PLL) in particular gaining 21.5% on the week, and Standard Lithium (NYSEMKT: SLI) shooting up a staggering 48.5%.

Larger Sociedad Química y Minera (NYSE: SQM), also known as SQM, scored a more modest 1.2% gain.

On Monday, all these numbers rolled in reverse. As of the close of trading, Standard Lithium stock was down 6.8%, Piedmont had dropped by 7.7%, and SQM was down by 5.1%. The question is: Why?

Why lithium stocks are tanking

You can probably blame investment bank JPMorgan Chase (NYSE: JPM) for the turnaround. On Friday, it pulled its overweight rating on SQM and downgraded the shares to neutral, citing a too-far, too-fast rise in the share price. (This late-breaking downgrade was one reason why SQM stock didn't rise as much as the others last week. It had been up by more before the downgrade).

Worse news for lithium investors, JPMorgan issued a bearish forecast for lithium prices worldwide -- and for the next three years.

Lithium that cost more than $85,000 per ton less than two years ago averages closer to $10,600 per ton today, according to data from TradingEconomics.com. Now, the good news for shareholders is that JPMorgan thinks this might get a little better in future years. But the bad news is that the bank doesn't think it's going to get much better -- and might even get a little bit worse. As TheFly.com reports, JPMorgan estimates that lithium prices will continue to average between $10,000 and $11,000 per ton "for an extended period of time of three years."

Given this forecast, JP warns that any "lithium price rally should be short-lived." Because even if lithium prices do rise a bit going forward, "there is significant dormant capacity that could come quickly to the market," increasing supply and pushing prices right back down again.

Which lithium stock should you buy?

What does this mean for SQM, which already produces a lot of lithium, and to a lesser extent Piedmont and Standard Lithium, which don't?

Well, assuming that JPMorgan is right about its forecast -- which is not certain -- it could very likely mean that SQM won't earn much of anything for the next three years (its year-to-date losses exceed $655 million) as it continues to depreciate capital investments already made. On the plus side, SQM has turned down the flame on its cash-burning capital expenditures of late, probably in response to low lithium prices. And the effect of that has been that SQM is currently generating positive free cash flow from its business -- more than $310 million over the last six months.

Even in the absence of higher lithium prices, SQM should be able to stick with this plan and generate decent free cash flow from its existing operations if it refrains from expanding production. And if JPMorgan is wrong and lithium prices do rise somewhat, SQM will have the option of just raking in extra profits, and coasting on its existing production capacity until prices get even better.

Piedmont and Standard are in more of a pickle, however. On the one hand, neither is producing much lithium yet (and Standard isn't producing any at all), so the price of lithium shouldn't really affect their profits (or losses) per se. Continued weak lithium prices, however, do mean any expansion Piedmont undertakes, and any progress Standard makes, is likely only to result in more losses, and more cash burn, for each.

In the current environment, I'm more enthusiastic about SQM's chances than I am the chances of lithium start-ups like Piedmont and Standard.

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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends JPMorgan Chase. The Motley Fool has a disclosure policy.