Shifting gears from gold to energy, Mercenary Geologist Mickey Fulp focuses on the latest rage: rare earth elements (REEs). In this exclusive interview with The Energy Report, Mickey discusses China's monopoly on REEs and the resultant shock waves still rocking Western industrialized countries and Japan. While fear of China protectionism looms, Mickey sees plenty of opportunity in "cream-of-the-crop North American companies" that are presently undervalued.
The Energy Report: You've been traveling quite a bit this summer. Can you highlight some of the places you've visited?
Mickey Fulp: I focused mainly on the northern tier of North America, which is what I generally do in the summertime. I looked at some gold companies, some uranium companies and some rare earth companies; these are the sectors I'm presently following. I was in the Yukon, Northwest Territories, Saskatchewan, Quebec, Wyoming, Idaho, Armenia and Haiti. All in all, it was quite a busy summer.
TER: You've gone to some remote places, which can be fun but also arduous traveling. From a geologist's perspective, it's apparent why you, as the Mercenary Geologist, look at your sectors from the mining angle. Each is so different in terms of what drives value, though; how do you build expertise in these three different sectors?
MF: I research commodities and commodity trends. As you're probably aware from my recent Mercenary Musing called The Trouble with Geologists (.pdf), I'm an economic geologist. I meld both economics and geology disciplines. I'm always looking for sectors that appear undervalued and trying to determine whether any catalysts are coming that will make them appreciate.
TER: What key elements help you decide whether a sector is undervalued? Are you looking at company financials? At the overall sector relative to other investment opportunities?
MF: That's a very good question. It's basically a study of commodity supply and demand. For instance, gold drives the Venture and the Toronto junior resource sectors. When the price of gold is robust, those companies tend to do well. We've seen that happen this year with the increase in the price of gold.
The rare earth sector is now the "flavor of the year" with the "clean green machine" crowd and Obama emphasizing renewable, less polluting, lower carbon footprint energy sources. Rare earth elements are critical to green technologies.
I'm bullish on uranium because it's the cleanest energy source we have and leaves no carbon footprint. A significant part of the world's electricity—somewhere around 12% to 13 %—is supplied by uranium. That certainly will increase in the future.
TER: As you say, rare earth elements are sort of the big new sector, the buzz sector, the darling. How long you have been following that sector? What appeals to you about it?
MF: I have been following this sector for over two years. I initiated coverage of a rare earth element company, Avalon Rare Metals (AVARF.PK) in June of 2007. That was a private report, so it never saw the light of day in the public arena.
In the middle of 2007, I started studying rare earth supply and demand. And while I'd known this previously, the research re-emphasized that China controls about 90% of the world's production. Over the last 20 years, through competitive policies, China has increasingly forced mining, recovery, processing and manufacturing facilities into their country. They've established a monopoly in these critical strategic metals.
REE's are essential for a number of applications, including defense applications and super magnets used in wind generators and hybrid cars. My research a couple of years ago got me thinking about this again and I became very interested in the sector.
TER: Before anyone was paying it much attention.
MF: Right. It's now become mainstream. You're seeing U.S. News & World Report, The Wall Street Journal, New York Times and Financial Times of London writing about the critical uses of these metals and that China controls the world supply. The reports have sent shock waves through Western industrialized countries and Japan.
We've seen CNBC running interviews with people from junior resource companies in this sector. There's no doubt it's a bubble, but it looks to me like a bubble that's early on. It's being blown up right now and I think it will last a while.
TER: Every time you hear about rare earth elements or rare earth metals, it seems that it's more of fear of China protectionism than really a shortage of the metals. Are we just too scared?
MF: I don't think China is doing this maliciously. I think China is seeing internal demand great enough that they can no longer supply the world; it seems to me a nationalistic issue in China. I think it's the same thing in the United States; we're going to develop our own deposits because we won't have a secure supply from China. The Chinese demand will be such that they'll use all of what they produce themselves. China's going to build more hybrid cars than anybody else. Whether there are supply shortages or not, it's crucial for the United States to secure its own supplies. You can't even build a cell phone without rare earth elements.
TER: Virtually all of our technologies require some of them.
MF: That's exactly right, and that's changed over the years. From the early 1950s until the late 1980s, the world's rare earth elements came from Mountain Pass near Barstow, California. It's on I-15 on the way from Las Vegas to Los Angeles.
The mine was developed in the 1950s by Molycorp, which created markets for these metals in television sets, catalytic converters and other high-tech uses of that generation. The Chinese in the late '80s and early '90s, with discovery of abundant supplies, cut prices to the extent that it forced the Mountain Pass mine to shut down. They could no longer compete.
So, although we do have these metals in the United States and Canada, we've been negligent in not developing them sooner. There are good prospects in North America, and the future looks bright for the rare earth element sector.
TER: The Chinese have so much production, and their mines are all up and running now. Because no North America mines are currently producing the rare earths, what's to keep the Chinese from operating like OPEC, and keep reducing the price so it never becomes economically viable to put any North American mines into production?
MF: The primary reason is that specialty metals don't trade on the world market, and I don't expect they ever will. The entire global production this year will be between about 125,000 and135,000 tons; that's a miniscule amount of metal. Rather than set world prices, I envision off-take agreements where the users' demands are secured by agreements with the suppliers, much the same as it is with uranium contracts now. The prices are negotiated for long-term contracts and locked in. Supplies have to be secured due to the critical nature of these metals. I think producers will negotiate prices that ensure the financial viability of their mines.
TER: We've seen some amazing run-ups in the stock price on some of these companies that aren't even producing yet. So is the bubble that is being created now anticipating that the importance of these metals will drive the desire to pay for it at any cost?
MF: Yes. For example, Toyota Motor Corporation (NYSE: TM) needs neodymium to build the Prius hybrid car. Whatever demand they anticipate over the next five or 10 years, they'll secure—probably via third-party interests—off-take agreements for supplies and secure arrangements to process the metals, alloys and powders required to manufacture neodymium-iron-boron magnets for Prius cars. So in this regard, I think the sector is going to operate somewhat outside of usual worldwide commodity supply-demand scenarios.
TER: But given the dramatic increase in valuations, is much upside left in companies that are prospecting for rare earths?
MF: Some of the charts look like hockey sticks. It's amazing how the valuations have skyrocketed. It's a bubble; there's no doubt about that. Whether these valuations are warranted at this point is very hard to determine because, number one, there are no peer comparisons. Number two, there are 16 metals in the rare earth portion of the periodic table, and each deposit, each company, has different ratios of the various metals. The individual metals trade at radically different prices, from $3 or $4 a kilogram to $400 or $500 a kilogram for some that are rare and in demand.
So to put hard numbers on the deposits and run financial spreadsheets with net present values and internal rates of return—none of the companies are at that point yet. I'm sure they do their own internal scoping studies, but these are pie-in-the-sky valuations. They're definitely overbought; in some instances the REE companies were trading at pennies six months ago and now they're trading in dollars.
And that said, I think valuations will go higher; in my opinion we're at the beginning of this pump, this bubble.
Certainly the companies are overdue for a correction, which could happen at any time. But after a correction occurs, I think we'll see higher valuations for the most part.
TER: How high will they go?
MF: If you listen to some people, they're saying $10 to $20 stocks. Who knows? If you look at the 2006–2007 uranium bubble, there were some ridiculous evaluations. The difference between the REE market and the uranium market is there are so few rare earth deposits and so few companies involved in the sector. Everybody who can go out and find a little rare earth element occurrence is going to try and promote that, and perhaps float new companies. But they're relatively limited. You're already getting some pretenders in this sector that perhaps have niobium or tantalum deposits, which always contain some rare earth elements. So companies with flagship niobium and tantalum projects and some in the uranium sector, suddenly they morph into rare earth element companies. Some of these are legit and some aren't.
TER: So if we get a pullback, do you suppose these pretenders may fall to the side and those with legitimate mines will see that even higher valuation going forward?
MF: I would think so. We saw that very much in the uranium sector; hundreds of companies came in with a high-grade uranium prospect in some remote part of the world, supported by helicopter or float plane. They washed out pretty fast. What we're seeing now in the uranium sector is a lot fewer companies, but more legitimate and robust companies.
As this rare earth element bubble progresses, I think you'll see a lot of pretenders come in but the contenders will be left standing at some point.
TER: Speaking about contenders, you mentioned Avalon earlier. What's Avalon doing today?
MF: Avalon is certainly one of my favorites. In the North American junior resource sector, Avalon is the company that is furthest along. They have a heavy rare earth element deposit. That's the portion of the rare earths where most of the shortages are projected and where most of the high-value metals are.
Avalon just raised $17.5 million in a bought deal financing, including flow-through and regular shares; it averaged about $2.50. The company hasn't seen $2.50 since then; it's recently around $3.50 a share. This was a 70-cent stock in mid-May; its valuation is five times that right now.
TER: What's Avalon doing on the operations front?
MF: They're drilling 50-meter centers to move the resource from inferred to mainly indicated. The program also includes core for metallurgical work. We'd expect another resource estimate to come out sometime in the late fall or early winter, and the pre-feasibility study early in Q1 of 2010. These items may be catalysts for higher stock prices.
Avalon's deposit at Thor Lake is about 100 kilometers east-southeast of Yellowknife in the Northwest Territories. A couple of weeks ago, the Yellowknife Dene First Nations and Avalon had a ceremony giving the project a new name, a native name. This is the first time that a native group has lent or recommended a name for a mine, which indicates to me that the group is very much on-board with Avalon's development in the Northwest Territories. I think that's very positive for Avalon.
TER: Which other rare earth companies do you consider contenders?
MF: Rare Element Resources Ltd. (OTC:RRLMF) is another of my favorites. They, too, recently did financings at $1.50 and $3, so with minimal dilution—and raised money for drilling and further metallurgical work that's looking very positive so far. They have two rigs on their project in the Bear Lodge Mountains of eastern Wyoming doing a drill program of 5,000 meters with indications of success. I visited that project last September.
This is a company the last time we talked was trading at about 75 cents. Now it's over $4. It is one of those hockey stick charts, but with catalysts that lead me to believe the valuation can be higher. It's positive, too, that Newmont Mining Corp. (NYSE:NEM) is in a joint venture with Rare Element Resources drilling the gold portion of this play, looking for a Cripple Creek style gold target.
Another company I follow in this sector is Quest Uranium Corporation (OTC:QSURF), which has both uranium and rare earth element plays and is now focused on the REE portion of their project inventory. Quest has the Strange Lake deposit in far northeastern Quebec. I was there about six weeks ago in some of the worst weather and difficult flying conditions I have ever experienced. They had two rigs drilling there.
They have a new discovery on this play; the B-Zone looks as if it will be substantial. It's presently known to occur over 1.7 kilometers of strike by 350 meters minimum width and about 3 kilometers from the Strange Lake deposit. But it is less eroded and better preserved; alteration zones are much thicker and more extensive. I am very bullish on Quest Uranium at this time. It is absolutely the proverbial hockey stick. On April 30, you could have bought it for five cents; it's $3 now.
MF: For people who signed up early on, the returns have been absolutely fantastic. Whether this is a sector you'd want to wade into right now, I won't speculate on that at all.
TER: Very early on in our conversation you were talking about how the clean, green interests have made the rare earths so popular now, and you said nuclear is our cleanest energy resource. Why haven't the uranium stocks taken off in this cap-and-trade, clean energy mania?
MF: The spot price is depressed right now, down to about $42 a pound, for a couple of reasons. Number one, we're getting very mixed messages from the Obama administration. On one hand, Energy Secretary Steve Chu on National Public Radio, which is just a bit left-leaning, suggesting that if you gave him a choice of living next to a nuclear power plant or a coal mine, he would choose the nuclear power plant. That would be viewed as positive for the nuclear energy sector in this country.
But at the same time, the DOE is advocating selling more uranium to the U.S. Enrichment Corp. (NYSE:USU). Although they're talking about another 5–10 million pounds per year, with 5 million representing something less than about 10% of the demand in the U.S., that's overhanging the market. It's led to uncertainty and a depressed spot price.
As we've discussed in the rare earth element context, most uranium trades on long-term contracts rather than the spot price. Nevertheless, while the spot price is a small percentage of the market, the uranium sector goes up and down based on the spot price. The DOE is using these uranium sales—previously on the order of $150 million per year—to fund cleanup work in places in the Tennessee Valley Authority, such as Portsmouth and Paducah. In addition, they recently denied a loan for a new enrichment facility in Ohio.
Bottom line, all of this uncertainty, vacillation and these mixed messages by the Obama administration disrupts spot markets, which leads to lower valuations in the uranium sector.
TER: Do you think this is one of those dips that is clearly opportunistic? Or is it a negative, that these mixed messages will keep uranium prices down?
MF: The mixed messages certainly have severely affected the spot price. Long-term contracts have held pretty steady—$65 to $75 a pound over the course of the past year. Asian sovereign funds moving into various countries, locking up contracts, and investing in uranium deposits and mines have caused me to be very specific in the junior uranium companies I invest in. So I've looked for cream-of-the-crop North American companies in this sector that are presently undervalued.
TER: Let's talk about them.
MF: I like Hathor Exploration Limited (OTC:HTHXF), and we've talked about Hathor before. Its price has been very beaten up over the last nine months or so. It was trading as low as a $1.40 or so until they recently announced the discovery of a new zone on the Midwest Northeast Project. There are no assays right now, but scintolometer readings indicate that this will be a substantial intercept. Hathor is now trading in the $1.70–$1.80 range. I would consider that a good entry point and look for a better share price for Hathor.
Another thing about Hathor… Denison Mines Corp. (NYSEMKT:DNN) was trying to acquire Northern Continental Resources Inc. (TSX.V:NCR) for their portion of the Wheeler River discovery, also in the Athabasca Basin. This is another very nice discovery that could be a substantial deposit and a mine in a few years. Hathor, being a cash-rich junior, made the better offer. Now Hathor and Denison are JV partners—the two of them since Northern Continental is in the fold with Hathor.
TER: Any others?
MF: Another junior I very much like in this sector is Strathmore Minerals Corp. (OTC:STHJF), which operates in Wyoming and New Mexico. Strathmore is the true super uranium junior company. Strathmore is focused on the Gas Hills of Wyoming and the Roca Honda Deposit in the Grants Mineral Belt of New Mexico. The company presently has about 140 million pounds in the ground resources—by far the highest number of pounds of any company in this sector. These two flagship projects will be relatively near-term producers.
Strathmore will monetize several projects that are not core assets, and recently announced the sale of one of them. They are selling their Powder River Basin properties to Bayswater Uranium Corporation (TSX.V: BAY) for $30 million. The monies from this sale will enable them to permit the two flagship projects and work toward feasibility.
So these are catalysts that could move the Strathmore price, which is presently about 60 cents. A couple of analyst reports coming out of financial institutions are also very bullish on Strathmore now.
TER: What does the timetable look like?
MF: We expect the mine permit application to be submitted very soon to the state of New Mexico for Roca Honda, and the commencement of a bankable feasibility study for that project early in 2010. In the Gas Hills, Wyoming, they are working on the draft of their mine application that will be submitted sometime in 2010.
TGR: Anything else you would like to tell our readers?
MF: I'd say, "Do your own due diligence." The successful investors in this business are the ones who research and study companies before investing in them. You don't want to be throwing darts at the board. It's a high-risk business; it's gambling. But you can skew the odds in your favor by doing careful research.
DISCLOSURE: Mickey Fulp
I personally and/or my family own the following companies mentioned in this interview: Avalon Rare Metals, Rare Element Resources, Quest Uranium, Hathor Exploration and Strathmore Minerals.
I personally and/or my family am paid by the following companies mentioned in this interview: Avalon Rare Metals, Rare Element Resources and Strathmore Minerals are sponsors of my website.
The Mercenary Geologist, Michael S. "Mickey" Fulp is a Certified Professional Geologist with a bachelor's degree in Earth Sciences with honors from the University of Tulsa (1975), and a master's degree in Geology from the University of New Mexico (1982). He has nearly 30 years' experience as an exploration geologist searching for economic deposits of base and precious metals and other resources. Mickey has worked for junior explorers, major mining companies, private firms and investors as a consulting economic geologist for the past 22 years, specializing in geological mapping, property evaluation and business development. Respected throughout the mining and exploration community due to his ongoing work as an analyst, Mickey launched MercenaryGeologist.com in late April 2008 and can be reached at Mickey@MercenaryGeologist.com