Rare Earth Elements

Rare earths are a group of not-generally actually “rare” elements that comprise (generally) one of the lines from the periodic table – here in the middle shade of blue:

These elements are increasingly of strategic importance. They are used to make high-tech magnets, catalysts, high-tech ceramics, superconductors/lasers, etc. Like almost everything else it touches, the US government has completely clusterf@#ked itself and us. It created all the financial structures that ensured that “dirty” businesses like manufacturing and mining would leave the US — in the thought that the US would advance into the post-industrial age and thrive in a world where our economy depends on us buying and selling real estate to each other while we export interest-rate derivatives and credit-default swaps to the rest of the world. So much for that idea of economic progress.

Now, the rest of the world depends entirely on China for mining the stuff — and the Pentagon thus depends entirely on China to supply its contractors with the high-tech material that is used to make the high-tech weaponry with which the US government can attempt to contain emerging global power threats — like China. China has now figured this out — and is now restricting the exports of these materials. The US government is still stuck on stupid but will, at some point, either learn or it will deserve to die. In the meantime, there are a couple of legitimate investment opportunities and a few dozen mining scams that have emerged.

The best opportunity IMO is a Canadian/Chinese producer of the high-tech “stuff” made out of rare earths. Their Chinese branch (Magnequench) is a formerly-American defense contractor and is THE major producer of stuff like high-tech magnets and such. Being Chinese-located now, they will have access to the raw ores and they already have the purchasing contracts from the major Japanese/American/European companies who put the components into end-use things. It is highly unlikely that China will restrict the exports of those products (for now at least) since that would almost be tantamount to a declaration of hostilities on the rest of the world. The company is NeoMaterial (NEM on the Toronto exchange – C$4 — and NEMMF on the pinks). It trades at a P/B=2; P/S=2: P/E=13; P/CF=18; market cap of $500 million — which is OK compared to the last 10 years. For them, however, the game going forward is completely different. They now have near-monopoly ability to set prices for their products for the next few years. And more significantly, if the share price does remain at these levels, then the Chinese will buy the whole company and keep the monopoly (and the embedded technology to turn ores into usable stuff) for themselves. The company seems to understand this and is buying back shares at levels that are only a bit below the current price. There are a huge number of catalysts for this company over the next couple of years unless the US government remains totally brain-dead beyond belief (which though unlikely is honestly an increasingly real possibility).

On the ore/mining side, the big new shiny IPO is Molycorp (MCP – $15). They own the mine (Mountain Pass) which used to be the main global supplier of rare earth ores until it was shuttered in 2002 because of low prices. They have just gone public and are currently owned by the usual crop of sharks and bailout/welfare squids. The current market cap is $1.2 billion – assets composed mostly of cash from the IPO and the old mine. Very different from most IPO’s, operating insiders bought part of the IPO. The cash they raised is almost – but not quite – the amount they’ll need to open the mine by late-2012. But guaranteed, until then the institutional squids/sharks will be flogging this stock like a recalcitrant donkey in order to try to get another bubble going here so they can sell into it. Whew – enough of the confusing metaphors. At any rate, there are a lot of catalysts here. Plus, they have signed a technology transfer agreement with NeoMaterials (in exchange for ore guarantees) so that they won’t get stuck with claims to a big pile of uneconomic dirt if rare earth mines open up all over the world in the next few years.

Most of the other rare earth companies – and there are lots of them that have staked a claim to big piles of ore and been hawking their penny stocks for the last few years for the impending “rare earths scarcity” – are basically huge risks now. One in Australia is probably OK since it is actually opening a mine in late-2011. The overall market simply is not anywhere near big enough to support new mines everywhere. I suspect that the story/hype will be big enough to keep many of them going “Vancouver-style” – but not for me.

I like these stocks in the order presented. NeoMaterials is the better buy here — in large part because it does have a liquidity premium attached and is more complicated to purchase from the US. Molycorp will likely be the better trading vehicle – and be the recipient of far more hype – but will also have the downside volatility and be overvalued. In truth, it is hard for me to know what that overvalued point is. The entire global market for rare earth ores was about $1.5 billion last year. Hard to know how much prices will rise in the next two years before new supply comes in and kills the high prices. But it seems to me that at current prices, Molycorp is already pricing in a near doubling of them. NeoMaterials just seems better positioned — at least until it gets bought out.

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