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The recent rare earth investment mania has exposed a not unexpected contradiction in the rare earth segment of the rare element mining investment space. The market prices of the shares of the publicly listed existing rare earth mining opportunities have, for the two existing Canadian companies, first gone up dramatically and then declined but they have settled at a much higher baseline than before. So have the share prices of the two most active listed Australian rare earth mining companies, since the beginning of August, 2009.

Additionally, the listed-rare earth-mining-venture-share-price-run-up has now also raised the share prices of many, if not all, of the existing and spawned a large new wave of rare earth wannabes. Most of these, in my opinion, have either no understanding of the rare earths or their potential future uses and market, or no direction as to finding a way to extract, refine, and process their ores to recover contained rare earth values. I might also mention that among the wannabes there were a few listed so-called rare earth opportunities actually selling fantasies of high grade high volume ore bodies on the analyses of a few carefully selected drill cores, most of which had been previously sold as evidence of other “deposits’ of metals, not the rare earths - desired at previous times by a volatile and fickle commodities market.

Institutional investors, public and private equity funds and banks often buy and sell shares of specialty metal companies based on the same factors and the same hype and promotion as small private investors do in order to make short term gains. Thus, stock pickers go orgasmic when they find out that an institutional investor has “taken a position” in one of their holdings of a bulletin board, pink sheet, or even NASDAQ listed junior (exploration) mining company. What the stock pickers call evidence of interest is almost always evidence of wanting to get into and out of a good thing while it lasts.

The institutional investors however are traditionally very hard on actual mining development. The rare earth mania has so far been no exception to the banker’s rule of avoiding high risk (or failure to produce anything) on long term investments. Such investments offer a low probability of any Return on Investment in a reasonable time that exceeds the return the institutional investor would get from merely putting its money in a “quality” investment, such as traditionally, US Treasury long-term securities.

Note well that even today when such quality investments as U.S. Treasuries are paying all time low returns, institutional investors are not placing long term bets on rare earth mining with their capital.

So far my analysis is not unusual. There is rarely any direct connection between a share price run up and the probability of a long term investment in a mining venture being successful through commercial production of a desired end product, so why worry?

I think that the market share-price-lifting “crisis” that has been caused by the promulgation of mostly hearsay evidence that China, the present monopoly producer, is (further) restricting exports of the rare earths and may even halt the export entirely of selected rare earths, is evidence of two things that are being masked by the now increasingly obsolete approach of western procurement officers, both public and private, to long term planning. These procurement officers have been taught in western business schools and are convinced that price is the critical driver of their ability to buy anything and that increased demand always increases supply.

The two things being masked by this belief are that:

  1. The selling prices of the rare earths outside of China are being artificially depressed; they are too low, and
  2. China is moving towards or preparing for the re-pricing of commodities, such as the rare earths, (in which it is world dominant in production and usage) out of US dollars or perhaps of revaluing the renminbi.

Interestingly enough, although the first factor above clearly explains why institutional investors are not making long term investments in rare earth mining - the selling prices are too low to give any, much less an adequate, return on investment - the second factor is a reason to make such investments. Because American production costs won’t go up if the dollar declines (most of the costs are independent of the relative value of the US dollar) but margins will skyrocket when and if the goods are exported to those consumers who will be buying many more dollars with their local currency and so are unlikely to reduce their demand solely because of a price increase in US dollars. Did I mention that I believe that Chinese production and refining of rare earth metals cannot keep up with Chinese domestic demand for much longer?

I have always believed that perspective is the key to objectivity. And although the mainstream media are now noticing that hard asset prices are increasing for commodities besides gold and that such price increases may in fact reflect the decrease of the value of the dollar rather than any increase in the value of the commodity, the MSM has not noticed that some commodities, for which the demand is in fact increasing, are nonetheless not increasing in price as rapidly as others. The MSM does not discuss this anomaly, because its perspective is too limited.

I’ve been watching the current stock market small investor interest boomlet in the rare earth elements, REEs, since it began late this last summer (2009). For small investors I think that the first wave of the “rare earth publicly traded share price rush” was triggered by an article by James Dines in his popular subscription newsletter. There he predicted that due to rapidly rising public awareness of their strategic and critical nature, a rare earth investing rush, mimicking the one he correctly predicted many years ago for uranium mining under similar circumstances of rising public awareness, was about to get underway.

It didn’t hurt the octogenarian Dines' prediction thesis at all when the news media, shortly thereafter, caught wind of a supposed Chinese pronouncement that would impact the future security of the supply of rare earths. This pronouncement, said to be an internal memo solicited by China’s Ruling State Council on the future supply and demand of rare earths in and by Chinese industry during the next “five year plan” cycle, 2010-2015, had first actually been noted in April, 2009. The Chinese, it was said, in a press release by the listed Australian miner, Arafura Resources, [ASX:ARU], were officially considering a continuation of the reduction in their export allocations of rare earths (the reduction of which they have been carrying out for the last 5 years), and (drumroll, please) it was said that they were contemplating an “immediate” cessation of the export of the so-called heavy rare earths (first four notes of Beethoven’s Fifth Symphony, please).

Although there are no “official” comparative production statistics for the rare earths, which are not traded on any exchange, it is believed by everyone who comments on this topic that the People’s Republic of China (PRC) today produces more than 95% of the entire world’s annual new supply of the rare earths. It is certain that the PRC today produces 100% of the world’s annual production of the very rare so-called “heavy” rare earths, dysprosium, terbium, and europium. These high atomic numbered rare earth elements - referred to as the “heavies”- are critical either for raising the operating temperature at which rare earth based magnets can perform efficiently, or for producing a red cathodolumenescent phosphors for color displays. “Critical” here means that without these rarest of the rare earths the functions they create cannot be performed. There are no substitutes for them.

There is, and has been continuously, since the mid-twentieth century some mining of rare earths in Russia, India, and, perhaps, Maylaysia, and there has been since 2007 a small amount of large scale processing of previously produced REE concentrates (70%) in Mountain Pass, California by MolyCorp. The Mountain Pass production is as of this writing 6 tons a day, apportioned between lanthanum [oxide], 4 tons a day, and didymium [80% neodymium mixed with 20% praseodymium] oxide, 2 tons a day. MolyCorp, at Mountain Pass, although it is a producer of rare earth oxides [REOs] is not currently mining or concentrating ore; it is working off concentrates last produced in 2002. I am using the convoluted term “small amount of large scale processing,” because I am certain that no one else outside of China is producing anywhere near the volume of REOs, daily, that Mountain Pass is.

MolyCorp is most likely producing between 40% and 67% of all of the REOs produced outside of China in a vertically integrated operation. It is important here to note that the Mountain Pass ore body was the site during the 1980s of the largest individual rare earth production level ever achieved in one mine. The open pit operation reached a level of 20,000 tons a year of REEs. The ore body that was mined at Mountain Pass is immense; it is an indicated (verified) resource of at least 30,000,000 tons of 9.6% average grade, with a cutoff grade of 7.6%, bastnaesite.

The reason that Mountain Pass was put on care and maintenance (i.e., shut down) in 2002 was not due to the exhaustion of high grade ore or the loss of access to such ore. The reason was simply that Chinese production out of the Bayanobo region of Inner Mongolia had by 2002 become priced so much lower than that at Mountain Pass that MolyCorp could only continue mining by subsidizing the cost, which it chose not to do since the trend was clearly for even higher Chinese production and lower pricing. It was not then and it is not now clear whether or not Chinese production costs could justify the selling prices of Chinese REEs. But there may well be subsidies available to Chinese miners from the state in order to maintain employment in Inner Mongolia that are not solely based on the world market prices for the products of the mines as they would be in the free market oriented West.

Whether the current Chinese monopoly in rare earth production was planned as a strategy fueled by predatory (lowball) pricing or simply happened as a consequence of adhering to a larger national plan to create employment and drive manufacturing dependent on a secure supply of the rare earths to China is only an important consideration outside of China. Because as of this moment China is still exporting enough refined rare earths such as metals, alloys, and fabricated products to keep the world market for these products going.

The problem that has been exposed by the “discovery” of the memorandum on rare earth export allocations is that it proves the conjecture highlighted by well-known Australian rare earth specialist, Dudley Kingsnorth, that Chinese domestic demand for rare earths is rapidly catching up to Chinese supply output. Mr. Kingsnorth has predicted that before the expiration of China’s next five year plan in 2015 Chinese domestic demand will exceed its domestic production.

Assuming Mr. Kingsnorth’s prediction to be correct, and I do, this means that at some point in the next five years it will not be possible to manufacture rare earth based products outside of China unless and until 1. There are rare earths produced outside of China; 2. Those rare earths can be refined and processed into useful forms outside of China, and 3. Chinese domestic consumers have not preemptively gained control over the non-Chinese production of the rare earths in order to secure their own supplies for domestic manufacturing and marketing within China.

What the recent hubbub over Chinese rare earth export allocations has exposed is that a deadline is rapidly approaching after which the production and use of the rare earths will pass by default to the absolute control of the PRC.

I and others have written extensively over the past few years about the importance, indeed the critical importance, of the rare earth metals in today’s age of technology. This importance seems now to have been noticed first by the market and finally by the US military establishment, which finds itself in the unenviable yet perfectly foreseeable position of becoming dependent on a foreign power, the PRC. The PRC, if not a military adversary of the US, is already a direct economic competitor of the US and the rest of the world for the raw materials, the rare earths, without which the US military cannot build its smartest and most effective weapons. To some it seems irresponsible in the extreme and, perhaps ominous that the US has allowed itself to become dependent on the PRC for any critical raw materials, much less such materials as the rare earths which the US has in abundance and of which the US was very recently the world’s largest producer.

It must also be noted that even without the military hardware consideration there are very few green technologies that do not need rare earth elements for critical aspects of their performance.

An excellent example of spin control - excuse the pun - has been projected by the “wind turbine generator” industry in the US and Europe. In the Spring of 2009 the PRC announced that over the course of the next two five-year plans (2010-2020) China would quadruple its previous commitment to building wind generators from a previously announced 33 gigawatts to a new total of 120 gigawatts. The western “wind” industry acclaimed this announcement whenever it was brought up as a vindication of their industry and as proof of China’s commitment to alternate energy production to reduce its, China’s, dependence of fossil fuels for energy generation.

In fact, the Chinese plan may throw the rest of the world’s attempt to build wind generating capacity into chaos. One of the most efficient and reliable of wind generators is based on the use of a permanent magnet type generator, which is most effectively made using a neodymium-iron-boron permanent magnet. Each megawatt of electricity produced by such a wind turbine type requires between 0.7 and 1 ton of neodymium-iron-boron. The construction by China of a 120 gigawatts of such capacity could take therefore as much as 120,000 tons of neodymium-iron-boron magnet alloy. This alloy would necessarily have to be produced with newly mined materials since it replaces nothing now using neodymium, and it can be estimated that it could require 250,000 tons of new production of rare earths over the next 10 years just to provide sufficient neodymium for the job.

The only nation that could possibly produce enough new neodymium in the next ten years to undertake the completion of such a project would be the PRC, and it could do this only by eliminating the export of neodymium or maintaining it, at best, at 2008 levels. Whenever I mention this to anyone associated with the wind industry I am accused of ignorance of other than rare earth based permanent magnets for wind turbine generators and of ignorance of other types of generators. Yet no one will tell me what would happen to the western wind turbine energy industry if it were now completely cut off from PRC material. It is clear to me that public companies that depend on subsidies to be competitive do not wish to discuss what the effect of delays, re-engineering, and lessened efficiency will do to their business models.

The most progressive of the world’s car companies in the electrification of the motor car, Toyota (NYSE:TM), has sold more than 1 million of its full hybrid Priuses since 1997. The current model, third generation Prius uses a 1.5 kWh nickel metal hydride (NiMH) storage battery based on the rare earth metal lanthanum in conjunction with a gasoline fueled internal combustion engine (ICE) to achieve a 50+ mpg fuel efficiency. Toyota has made it clear recently that based on its own three year study of currently available lithium-ion storage batteries it, Toyota, has decided to indefinitely continue the production of the Prius with its current NiMH battery and to ramp that production up to 1 million units per annum by 2011. Toyota makes its own NiMH batteries from its own in-house design, so that it feels directly any Chinese export reductions or eliminations.

Although Toyota does not disclose the amount of lanthanum and other rare earth metals it uses in the construction of the Prius type power train I can safely estimate that Toyota annually uses at least 7,500 tons of lanthanum and 1,000 ton of neodymium. I don’t know how much praseodymium, dysprosium, and terbium Toyota uses annually, but I would guess that Toyota is the world’s largest single user of all of the rare earth metals named. Toyota thus has good reason to be concerned over the security of its supply of Chinese REEs and this gives it good cause to be proactive in seeking out alternate sources of REEs globally. In fact, Toyota has done that, and it is in the process of doing more. That story however is for another article.

I have now come to the topic I wish to discuss. With the need for the REEs for strategic and critical civilian and military manufacturing growing and with China cutting back on its exports of REEs to secure its own supplies of these strategic and critical metals, why are private capital and the federal government state not placing a priority on reviving rare earth production and processing in the USA, even as they throw hundreds of billions of dollars at green technologies which will not be efficient, or even, in some cases, functional without rare earth based components? Why doesn’t the US military seem concerned with its dependence on a competitive power for the critical and strategic materials for so many of its highest tech weapons and weapons’ platforms?

There is no explanation other than sheer lethargy for the lack of state action; if it’s not really broke, why fix it seems to be the rationale for non action. Military procurement officers will tell you that so far there has been no problem sourcing the relatively small amounts of REEs needed for military production, so, they say, why “create an issue where there has been no problem?’ It is not just the American military that ignores long term strategic planning for even critical materials; short term thinking is, in fact, the norm in American private industry.

But there is even a better reason than short term thinking why private capital is not being directed to the development of non Chinese sources of the REEs.

To be concise, it is because at current rare earth prices there is no chance of any return on investment from any rare earth mining ventures, public or private, that do not contain the heavy rare earths in significant quantity and even then such a venture to be profitable will need to have not only the heavy rare earths but also either have the light rare earths or be combined with a venture that does.

Additionally, there is no point to developing a rare earth mining venture unless it is accompanied not just by a refining operation to separate the individual REEs from one another but also to produce the pure rare earth metals and the necessary alloys and compounds required to manufacture products critically dependent on the REEs. In other words, any investment must also be over the entire supply chain or have access to such a supply chain.

To understand the dilemma look at the declining copper mining industry in the USA for example and contrast it with the rare earth mining industry.

America has not only copper mines, but also copper refineries, copper fabricators, and copper end product manufacturers. Copper mined in Utah, for example, can be smelted in impure “blister” copper and then refined into high purity copper cathode in Utah. Then the cathode can be drawn into wire in a place like St. Louis; then the wire can be used to make OEM automotive wiring harnesses in Ohio, and the wiring harnesses can be installed in cars being made in Indiana. America through its fascination with globalization does not today mine enough copper to feed its domestic demand, so it must import copper cathodes from abroad. America could however produce enough copper to satisfy its own demand and it is still self sufficient in the value chain for copper containing products such as electric wire and electric motors so that even if the copper cathode is imported, most of the value added to the copper by forming it into electric motors can be done in America by American workers. Keep in mind that when value is added to a natural resource it creates jobs and wealth.

This is not true of the value added to products by the use of rare earth components. Rare earth magnets are for example only manufactured in one type in small quantities by one American company which imports the rare earth metals, which it alloys in-house from China because no one in the USA today produces rare earth metals or alloys even, I do not believe, from the REEs produced by MolyCorp in California.

So the only wealth creation possible today in North America from the rare earths, after they are mined and concentrated and in the sole case of Molycorp, separated into their crude oxides, is the added value of those rare earths to Chinese rare earth refiners, metal and alloy producers, and fabricators of the industrially useful forms of rare earth metals and alloys. Most of that material is further processed into magnets, batteries, lasers, motors, generators, and displays within Asia, predominantly China. So the added value to any rare earths based products that would be produced today anywhere in the world outside of China would be added mainly in China and to a lesser extent in Japan and Korea.

One of the reasons that Australia officially rebuffed the recent attempt by China Non Ferrous Metals Company to acquire Lynas Corp’s (OTCPK:LYSCF) Mt. Weld mine was that the investment would have created only 90 jobs in Australia while insuring the creation of 400 jobs in a Maylaysian refinery and untold numbers of jobs in China where final reduction of the refined oxides to metals and alloys, as well as the fabrication of those metals and alloys into end use products, would have occurred. Australia’s government is now questioning the business model of Lynas and asking why the refining, metal production, and component and end-use product manufacturing supply chain cannot be erected entirely within Australia creating new wealth and jobs from what up until now was considered merely a natural resource. It is ironic that until recently it was not possible to get government interest in Australia in assisting in the development of the rare earth industry - actually the re-development, since Australia was producing rare earths in the second half of the twentieth century, but like America got globalized out of the business by China.

China clearly has already recognized and adopted the closed loop, or perhaps more technically correct, feedback, model for creating wealth and jobs from a natural resource in which it is dominant. Australia is on the verge of catching on to the Chinese model. Canada and the United States are both in the process of waking up to the success of the Chinese business model for maximum wealth creation from natural resources.

But China operates by state action whereas all of its present direct competitors use some form of free enterprise. China’s competitors are and can only be industrialized nations that are blessed with natural resources and high technology industries. In the case of the abundant natural resources, free market capitalism triumphed first. But in the case of rare metals, where individual production or manufacturing may be uneconomical, only collaborative action (such as Chinese state action) can work unless prices get so high (as in the case of the industrially useless rare metal gold) that even though enormous investments must be made in order to produce small amounts such investments can be profitable.

Some examples of why China is considering totally restricting the export of the critical and strategic rare earth metals will tell the whole story. Deep drilling for oil is not an area where the Chinese are known to have high expertise but they may soon have a cost advantage anyway because the electric motors driving the drills deep under the ground or the ocean are made with permanent magnets made to operate at the highest possible temperatures - it is impossible to cool such motors well at depths of thousands of feet. The best permanent magnets for such motors are probably those made from the alloy Neodymium-iron-boron. The alloy itself must have additions of dysprosium and terbium, which are today only and solely available from the PRC and are very rare, in order to be able to operate at the highest temperatures that can occur. It must be obvious to the world’s oil companies that shortly they will be unable to buy or have made new motors for deep drills other than in China. It must also be obvious to them that if Chinese oil exploration companies place orders for the same motors they will ultimately simply be unavailable to non Chinese oil drilling companies.

I should also point out that the American domestic maker of permanent magnets, Electron Energy, has produced some amazing high temp Sm-Co alloy for permanent magnets for motor applications using the mid-atomic-number range rare earth element gadolinium as an additive. There is today no North American production either of gadolinium or of samarium, although MolyCorp told me that they hope to produce both, as oxides, from their above ground concentrates in California within a year. In the meantime, and if MolyCorp does so, Electron Energy will remain totally dependent on the PRC for the critical rare earth metals it needs to make its high temperature operating permanent magnets, for which it is the principal supplier to the US Department of Defense.

Yet even if an oil company or an industrial company like Toyota were to agree to pay for the development, for example, to bring Avalon Rare Metals (AVARF.PK) or Great Western Mineral Group’s mining ventures into production there would still be a need for the rest of the supply chain to be built simultaneously or China will still be in control due to its absolute dominance of the value chain for the rare earth metals. No one in the world of institutional investment seems to care about rare earths, because the total market size for the current global production of rare earths at the mine is less than two billion dollars.

The only hope for the further availability of the rare earths outside of China after 2015 is a collaborative effort by the rare earth mining, refining, metal and alloy production and fabrication, and end use product manufacturing industries to build a complete rare earth supply chain. This includes, by the way, a recycling industry targeted at recovering the rare earths from civilian and industrial products and processes, in one country, such as Australia, Canada, or the USA, or, at least, on one continent, North America.

This and this alone can create enough value to justify the total investment required. It makes no sense at all just to invest in mining either the light or the heavy rare earths. At today’s selling prices and even at the prices projected over the next ten years there is little or no hope of any return on such investment and therefore no private investors will undertake such a venture other than to make money by the increased value of their public share holdings.

The public, without any analysis, is hypnotized by the hype. In the stock market holders of shares are betting with each other on the company’s future; they are not analyzing the company’s future nor understanding fundamental issues such as the current monopoly held by China and the value to China’s domestic economy of the rare earths.

Chinese companies owned by the state do not fail if they are unprofitable; they fail only if they are not needed by the next five year plan.

The Chinese rare earth mines are critical to not only the growth of the Chinese domestic technology culture but to its very existence. Balance sheets don’t matter. As soon as Chinese industry needs raw materials these are directed from the heavily indebted to the government mines to where they are needed. Foreign buyers are simply told that the desired material is sold out. This is exactly what American short term thinking has done to our heavy industry and is now doing to our high tech industry. The rare earth supply crisis is a symptom of a greater dilemma. It is time for collaborative action right now, before it is too late.

Disclosure: No positions

Source: On the Rare Earth Crisis of 2009