Rare-Earth Investment Update

 

Dear Readers,

Greetings from, the Congo – yes, the 21st century has reached even here, where UN tanks and artillery units remain entrenched, roads remain few, and there are both guerillas and gorillas in the jungle. Makes it interesting to read the news below on Africa, while exploring the Heart of Darkness.

Rock & Stock StatsLastOne Month AgoOne Year Ago
Gold1,711.501,637.001,353.25
Silver33.5529.6929.80
Copper3.833.514.54
Oil99.05102.2485.44
Gold Producers (GDX)54.4954.4755.93
Gold Junior Stocks (GDXJ)27.9626.5436.83
Silver Stocks (SIL)24.2122.7523.61
TSX (Toronto Stock Exchange)12,389.4212,270.6613,840.57
TSX Venture1,653.551,542.232,347.82

As a quick aside, I was talking via Skype with Doug Casey last night while sitting on the shores of Lake Kivu, which Doug visited 13 years ago, not long after one was as likely to see dead bodies as fishing boats on the water. He was reiterating that his guru sense is that economic conditions will deteriorate significantly this year – he still feels that the global economy will exit the eye of the storm in 2012.

More on that soon. Meanwhile, we have another installment in our periodic sweep of the various metals markets… this time a look at rare earths. This is an interesting sector in which some people are going to make a lot of money – but more people are probably going to lose money. Enter with caution.

Sincerely,

Louis James


Senior Metals Investment Strategist
Casey Research


A Rare Earth Update

By Alena Mikhan and Jeff Clark

We've received a number of inquiries from subscribers about our opinion on the current rare earth metals market. We have covered this topic previously, and also in an International Speculator piece. In this article, let's take a fresh look from the 50,000-foot level.

As a matter of a recap, rare earth elements (or REEs) is a generic name for 17 metals widely used mostly in high-technology devices, such as mobile phones, laptops, flat screen televisions, hybrid car batteries, lasers, optics and military equipment. New uses for these metals are being constantly found, but more on that later.

Despite the name, these metals are not actually rare in nature. The name refers to the fact that they are rarely found in a pure form and are usually mixed with other minerals, which makes extraction complicated and costly. Further, mining and refining of rare earth metals is environmentally challenging, due to acidic and radioactive byproducts. This is why most countries don't produce REEs. This has led to a reduction in reserves of these metals and left the bulk of production to less environmentally conscious companies and jurisdictions. China has expanded its production and, at least on the surface, looks to have a near monopoly on the industry. According to the US Geological Survey, China possesses one-third of the world's reserves and produces 97% of global supply.

None of this was a problem until China started introducing trade limits. Dramatic changes took place in 2010, when Beijing officially decided to cut export quotas on rare earths by 72%, to 35,000 tonnes, far below the levels of world consumption. Quotas were further reduced by 35% in the first half of 2011. Steep export taxes were applied, too. As a result, REE prices skyrocketed.

(Click on image to enlarge)

Consumers lost some of their appetite for the now-expensive metals, and most REEs dropped in price – some of them by as much as two-thirds. Prices remain above historical norms, however, and were so lofty that exporters used only half of the Chinese quota allocations last year.

It's hard to miss the steep rise in prices from mid-2010 to April 2011. Should we expect similar price spikes in the future? And what's the long-term trend?

Analysts have opinions supporting both bullish and bearish outlooks. Some think another price rally is possible, since the industries using REEs are on the rise and also because there are, in the majority of cases, no substitutes for REEs. Neither is there an immediate solution to the market conditions caused by China's supply policy. Others believe that the REE market will face a surplus in 2012 and that prices will thus correct further.

The REE market is precarious because supply is artificially restricted. This imbalance can't be sustained for long, though, because industries and companies that use REEs need to have predictable and stable long-term supplies of the metals and hopefully at reasonable prices. It thus seems reasonable to assume that the market will find ways to decrease the effects of China's policy.

In fact, there are some adjustments already under way in this market…

New Mines Outside China

Given the high REE prices, some previously producing REE mines are going back into production. Molycorp Minerals, for instance, is reopening its Mountain Pass Mine, which was shut down in 2002 because of competition from China and environmental concerns. The company was recently permitted to resume its operation and is expected to start producing this year. Another recent example is Australian miner Lynas, which obtained a license to begin processing rare earths at a new facility it's putting the finishing touches on. The company says by the middle of the year the plant will be able to process 11,000 tonnes of rare earths per year (about one-third of current world demand excluding China), and will later double its capacity.

Recycling

Another solution to cope with supply shortages is recycling. Japanese companies have been studying the technology and costs of reusing neodymium and dysprosium from washing machines and air conditioners. Mitsubishi Electric has made some progress by creating a device that extracts rare earth elements from used household air conditioners. The machine "will be installed at a factory run by Green Cycle Systems Corp., a Mitsubishi Electric subsidiary in the city of Chiba and begin operations in April." Another Japanese company, Shin-Etsu Chemical, announced that it will spend 2 billion yen ($US25.8 million) to build a plant in Vietnam to process REEs from hybrid car motors and other products. The factory is expected to open in February 2013 and will produce 1,000 tonnes of rare earths per year.

If recycling technologies can manage to be cost effective, they will become another source of REE supply, albeit not as significant as new mine production.

Replacement

Another way for companies to be less dependent on China's policy decisions is through new technology that uses less REEs. A widely quoted example is a company called Showa Denko, which managed to decrease its consumption of cerium oxide by half in 2011 by reusing the material up to five times, among other technological improvements. Other breakthroughs are likely to follow.

Relocation

China officially mined 93,800 tonnes of REEs in 2011, only 5% more than in the previous year. Harsh export quotas and modest growth in mine supply are considered by some analysts as the incentive "to give priority of supply to domestic consumers and encourage foreign customers, mostly in high-tech strategic sectors, to move their operations to China." Whether or not they like it, the state of the current REE market may force some companies to relocate their production facilities to China. Japanese companies Showa Denko and Santoku, among others, have already done so.

Conclusion

It's clear that REEs have investment merit. These elements are crucial and irreplaceable for a lot of consumer uses.

However, the REE market is small, opaque, volatile, illiquid, and subject to manipulation. It's further complicated by a lack of reliable data, making it difficult to forecast and risky to play. It's also worth remembering that REEs are industrial metals, which are usually weak when the economy enters a recession – an outcome we think is more likely than not.

Buyer beware.


Gold and Silver HEADLINES

Iran Paying for Grain with Gold, Oil (Reuters)

Gold and oil are being used by Iran as a medium of exchange for purchasing food from Europe. Facing financial sanctions imposed this year to punish Tehran over its nuclear program, Iran had to find alternative ways to pay for its imports.

"As the shipments of grain are so large, barter or gold payments are the quickest option," says a trader.

This reinforces the truth that gold is money.

Many African Miners Face Soaring Costs (Reuters)

The continent's miners continue to face a variety of problems, including labor issues, power problems, and increased tax burdens.

In South Africa, high inflation prompted unions to demand double-digit wage hikes. Zambia – Africa's top copper producer – recently doubled its copper royalty to six percent and may bring back a mining windfall tax if copper prices reach $10,000 per tonne. Its government is also considering a plan that would effectively be a 50% tax on mining earnings. The government of Africa's second-largest gold mining country, Ghana, plans to raise the corporate mining tax to 35% and to introduce a 10% windfall tax – both to boost the state's share of revenues.

As investors, it pains us to read news like this. Not all measures are the same, however (taxes on profits assume that there are profits to begin with, unlike production royalties), so the political risk in these countries needs to be examined on a case-by-case basis.

[We do follow an African producer in BIG GOLD, one with much lower political risk.  It recently wowed the market with its quarterly report. And get this: gold production will grow every year for the next five years. Get this company's name and stock symbol with a no-risk trial subscription to BIG GOLD. The current issue has a one-time offer you simply can't pass up: no premium on your first $1,000 purchase of gold or silver if you sign up for auto deposits in what we're convinced is the best accumulation plan in the industry. The offer only lasts until the end of February and could pay for your entire subscription, so don't miss out.]


This Week in International Speculator and BIG GOLD – Key Updates for Subscribers

International Speculator

  • One of our explorers released a batch of new drilling results. While it is not clear how economically significant they are, we are pleased to see that the drilled zone is growing and remains open. See our full comment on this company.
  • One of our South American gold explorers with a large, low-grade deposit has just announced more new discoveries. Is it enough to change the story?

BIG GOLD

Feb 13, 2012