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Thursday, October 28, 2010

Rare Earth or Common Disaster?

China has been in the news lately regarding the fact that they control 97% of the world’s supply of exotic materials that fall under the Lanthanide group. If you think back to your high school chemistry class I am sure Dear Reader that you had to study the periodic table.  When it came to the Lanthanide group of elements they were glossed over as if they did not exist. Elements like Neodymium, Gadolinium, Lanthanum, Cerium, and thirteen other elements were not in as wide spread use as they are  today.  Today these elements are irreplaceable in many of the electronic devices that we take for granted ranging from cell phones, alternative energy windmills to precision guided bomb control systems. The general public is waking up to the reality of the Rare Earth dilemma. The US military is also keenly aware of the fact that it is dependent on China for components of many of its highly sophisticated weapons systems; to the military it is a matter of national security.

Just like Russia did with its natural gas embargo of the EU countries, China has flexed its muscle and threatened Japan that it would cut off its exports of Rare Earths to the island nation over the detention of a fishing trawler captain. Japan does not take this lightly as their economy requires these elements in many of their manufacturing plants to keep their export economy humming. While WTO rules prohibit countries from restricting exports of materials in order to force other countries to buy value added products, however, countries are allowed to restrict exports for conservation.  According to Chinese official Chao Ning of the commerce ministry the country only has between 15 and 20 years worth of the heavy and medium Rare Earths which are the ones used in the high tech applications.  This is posturing for the Chinese to be able to utilize WTO rules to control markets and potentially use Rare Earths as leverage against the US, particularity when it does not like specific policies like money printing, tariffs  or criticism of Taiwan etc...

Recognition that there is at least a temporary Rare Earths crunch and given its critical use in our economy congress is getting in to the act with “Rare Earths and Critical Materials Revitalization Act of 2010”  which provides grants and loans to develop rare earths projects. Many of the Rare Earth companies have skyrocketed in price over the last few weeks. A new market favorite is Molycorp (NYSE:MCP) a Colorado based mining company  which is looking to restart what was the world’s largest Rare Earths mine located at Mountain Pass in California.  The attraction to this particular company is that it is the largest formerly developed Rare Earth mine in the Western hemisphere. Additionally, MCP has a 30 year mine plan permit and environmental impact study both issued in December of 2004; which is a plus since these items can be a real hurdle and time delay to starting a mine. So MCP is a development mine with a twist since they have the permitting and proven and probable reserves of 2.21 billion pounds of Rare Earths with an average ore grade of 8.24%. In many respects investing in MCP is like taking a position in a late stage junior development company the risks stem more from the typical mining related issues that crop up. MCP currently produces 3,000 tons of Rare Earths for commercial applications, but expects to ramp up to 20,000 tons as it expands it facility in 2012.

MCP sounds like a slam dunk doesn’t it? Of course there will be competition from companies like Rare Element Resources (AMEX:REE) currently in development and drilling phase but has a 100% interest in Bear Lodge in Wyoming, which according to the USGS contains one of the largest Rare Earth deposits in North America. The competition goes beyond North America for example there is Lynas Corporation in Australia  who is proceeding along in its plans and recently penned a deal to supply a Japanese buyer .

Right now it appears that the Rare Earths mining companies(REMCs) could continue their rise, even Molycorp’s CEO was on CNBC, “I don’t believe that there is a bubble,” Mark A. Smith, president of the Greenwood Village, Colorado-based company, said in an interview with Susan Li on Bloomberg Television’s “First Up.” “These prices are absolutely sustainable and that’s really based upon the very simple facts of supply and demand.”

I hate to throw cold water on this run because it is one of the sectors that does seem to be really outperformning, but I have concerns. The current parabolic rise of Rare Earth stocks is unsustainable from what I can see. I do believe higher prices of the elements themselves are required to bring supply online , which is why MCP is moving now to increase production. The issue I have is not with the cost of the elements, but the REMCs have run parabolic while most have no real production at least not yet. MCP who is producing some material is valued by the market at $3 Billion while the entire Rare Earth industry’s total sales of $2billion , moreover they are carrying a large nut to finance their ramp up. Furthermore, there is the potential that many of the explorers for Rare Earths will come on line and affect Molycorp’s pricing ability. It takes time to bring a mine on line especially in the US but in other parts of the world the timeline can be dramatically shorter, so competition could appear sooner than expected.

It appears to me that everywhere I turn on TV or in periodicals the Rare Earths are being hyped.There is newly found concern over Japan’s ability to get Rare Earths as well as the US military and a growing recognition that the supply side of the Rare Earths equation has to be dealt with.  At the moment it seems like everyone feels that we will run out of rare earths and it is straight to the moon for prices. This reminds me of the Uranium “bubble” of a couple years ago and I think it is going to end the same way. Conversely, Uranium appears to be a hated asset at this time and I think would be a better investment than Rare Earths at the moment. I guess life is full of Ironies since as I have been putting this post together China is coming out and stating that they are resuming Rare Earth shipments, which comes as the release of the new Rare Earths ETF makes its debut. I see MCP and REE are taking large hits right now, the easy money has been made and just like Uranium patience will give you a better entry point. I guess we have the answer now it will be a common disaster at least for the moment.

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