Chris Ecclestone: Right Size, Right Metals Signal Success For REE Projects

by: The Gold Report


Beginning this year, there's been a better vibe in the mining markets in general. REEs have started to pick themselves up off the floor.

Prices have bottomed, yes. Some people remain bearish on lanthanum and cerium, which are in massive oversupply.

I think the Chinese are more interested in controlling the prices of REEs than the supply.

The rare earth elements sector is smaller than it was a few years ago, and Chris Ecclestone, mining strategist with Hallgarten & Co., thinks it needs to get smaller still. The only way to succeed, he tells The Gold Report, is by finding the right-sized project with the right REEs. He also shares his theories on China's manipulation of REE prices and touts the mineral wealth of Spain and Portugal.

The Gold Report: In a March Hallgarten & Co. research report, you noted that rare earth elements [REEs] had "come out of hibernation." Did they wake up happy or grumpy?

Chris Ecclestone: The REEs have run hot and cold since 2009. They had a run for about a year, went off the boil, then had another run.

This all coincided with the worst overall mining equity market in 10-15 years. Thus, REE stocks were doubly out of favor.

Beginning this year, there's been a better vibe in the mining markets in general. REEs have started to pick themselves up off the floor. They look like a viable investment alternative again. However, I believe that we need at most 20 REE stories. Right now, two are in production. Another four or five will get into production over the next few years. We probably don't need the rest. There will be a race to get into production. If you can't win that race, you might as well pack up your tent and go home.

TGR: Do you see higher REE prices? Has the sector bottomed?

CE: Prices have bottomed, yes. Some people remain bearish on lanthanum and cerium, which are in massive oversupply. Those prices may go lower. However, I believe it's not in the Chinese interest to see those two metals go lower. Lanthanum and cerium make up the bulk of what China produces in the REE space, but they're not the value-added metals. Metals like europium may enjoy better prices, but they're a small part of the whole REE complex.

China's bread and butter comes from Bayan Obo, which is not a rare earth mine at all. It's an iron ore mine that produces REEs as a byproduct. The Chinese can't stop producing REEs at Bayan Obo because they'd have to stop producing the iron ore as well.

One of the intriguing things about REEs is that you can't just take the ones you want and leave the others behind. You have to go through the whole chemical extraction process to get those with the biggest market or the best price. You can't send a metal into the tailings pond because it doesn't have a good price today. You have to do them all.

You're stuck in a reverse economy of scale; the more you process, the more unprofitable it could be.

TGR: Given the margins on producing a concentrate or even an oxide, is vertical integration the only way to make money in the REE space?

CE: The ideal scenario is to be vertically integrated. That is a bit of a challenge for some of the juniors.

Like silicon technology, the mining is not the sexy part of the REE business. No one would say that digging silica out of the ground is the quality end of the tech business. The quality is at Intel's factory, where the silicon chip is put on the circuit board. The mere insertion of the word "rare" in the name was a marketer's dream and has ended up being an investor's nightmare. They're not rare; they're as common as dirt.

TGR: The World Trade Organization [WTO] recently ruled in favor of the U.S. in a trade dispute over Chinese exports of REEs, tungsten and molybdenum. Does that change the playing field for junior REE development companies?

CE: No, because it won't have much effect on the REE market. I recently attended an antimony conference, where we heard about China's quota on antimony exports and the fact that it never reaches its quota. Yet, according to the official statistics of individual European countries, their individual imports of antimony from China are higher than the entire Chinese export quota. Chinese export quotas do not affect daily life in the REE sector. They will be smuggled out; they will be walked across the border and become Vietnamese REEs.

I think the Chinese are more interested in controlling the prices of REEs than the supply. Call me conspiratorial, but I think that the Chinese sunk the REE prices in 2011 after having pumped it up. They did that because there was a sudden proliferation of REE properties out of nowhere in the west. The Chinese thought, oops, we've shot ourselves in the foot here by attracting all these additional mines. If we let them run down the track with these high prices, five years from now there will be massive overproduction. At that point, the Chinese sunk the prices.

The REE market is easy for the Chinese to manipulate because they have the stockpiles. In 2011, the Chinese released a deluge of product. That sank the price and 75% of the listed REE equities into oblivion. I think the Chinese want to see the prices rise again, but only when they can be confident higher prices won't trigger another surge of new REE companies.

TGR: How is China's role today different from its role in 2010-2011, when the sector exploded?

CE: It plays essentially the same role now. In 2011, China was pretty much the only game in town. India, Malaysia and Brazil had small amounts of production. Today, Molycorp (MCP) and Lynas (OTCPK:LYSCF) look like wounded beasts. They have, just barely, managed to spoil the lanthanum and cerium market for the Chinese. Their existence means that the Chinese don't control those markets anymore. I still don't see either one as competition for the Chinese, but they are price spoilers at the cheap end of the REE space, in lanthanum and cerium.

TGR: If China is the kingmaker and in control, why would an investor wade into these waters?

CE: There are niche categories. One of them is strategic metals. In 2010, you heard a lot about the perception that the West had made itself too vulnerable to Chinese supply of the strategic metals that the western defense establishment needs. Here we are four years later. China is as threatening or as non-threatening as it was back then.

Will the U.S. do anything about it? So far, not much has happened. The U.S. needs to say, "We need a big stockpile of yttrium, of terbium and samarium and other scarce REEs." Ironically, when you're talking about rare earths used for, say, night vision goggles, the U.S. defense establishment is probably buying the rare earth oxides that go into those from Japan or China. Meanwhile, Japanese are dependent upon the Chinese. Many of the Japanese plants for processing REEs are being forced to move to China because the Chinese have said, "You're not getting it unless you move your plant over here." They're almost like captives of the Chinese and the Japanese don't like that. The U.S. doesn't seem to care.

TGR: Are you following other REE names?

CE: One project without pitfalls in terms of good infrastructure and location is Tasman Metals Ltd.'s (NYSEMKT:TAS) Norra Karr in Sweden. Scandinavia is where REEs were first found. Norra Karr might come to fruition.

TGR: Is ilmenite your favorite mineralization to host REEs?

CE: Ilmenite is not my favorite. It is a titanium-driven product. If the price of titanium goes to hell in a hand basket, some ilmenite projects would follow.

I love xenotime because you get yttrium along with it. I like yttrium because of its high-tech uses in anything that must be coated to protect them from very high heat, like jet engines. it's a very interesting strategic metal.

CE: With REE prices going lower, all bets are off. However, you could build a mine with that amount of money.

TGR: Besides financing, what else does the Bokan Dotson project have going for it?

CE: It's the right size. It's better to have a project that runs out in 10 years rather than trying to build the biggest project.

It will be 2016-2017 by the time Bokan Dotson gets built. Some REE prices will be higher then: praseodymium and neodymium, the ones used in wind turbines and in hybrid autos. The Chinese are trying to deal with urban pollution by a wholesale shift toward hybrid autos.

We've seen this over and over in China. When China needs something, it starts by using all of its own product. Then it starts importing the product because demand outstrips production. That's not to say that China will become a net importer of REEs, but if China goes for a big paradigm shift into hybrid autos, it could generate massive demand for neodymium and praseodymium, to be used in the magnets in the engines.

TGR: The WTO ruling also covered Chinese tungsten. Can you update our readers on the supply/demand equation for tungsten and your investment thesis?

CE: One of the main uses for tungsten is the filaments in electrical light bulbs. The shift toward low energy-consuming bulbs reduces tungsten demand in that industry.

It's also used for hardening, including machine tools. China wants to muscle in on the traditional European strength in machine tools. That means using more tungsten, which is what led to the Chinese export quotas on tungsten. Those quotas frightened a number of European companies that depended on Chinese tungsten.

TGR: What should investors expect in 2014 and beyond in the REE space?

CE: I compare the REE space to a science-fiction movie, where the spacecraft crew is cryogenically frozen. Some of the crew will defrost the way they're supposed to, but others will be lost.

In the REE space, it will become clearer over the next 12 months which five or six projects are most likely to survive. Many of the other REE companies will change their names and become totally different companies seeking other metals in other countries.

I don't think there will be a second wave of new REE stocks. This is the universe we have, and it's getting smaller, not bigger.

TGR: What's your advice to investors Chris?

CE: Diversify. If you want to take on REE stocks, buy two or three to mitigate risk.

TGR: Chris, thanks for your time and your insights.

This interview was conducted by Brian Sylvester of The Gold Report.

Christopher Ecclestone is a principal and mining strategist at Hallgarten & Company in New York. He is also a director of Mediterranean Resources, a gold mining company listed on the Toronto Stock Exchange, with properties in Turkey. Prior to founding Hallgarten & Company in 2003, he was the head of research at an economic think tank in New Jersey, which he had joined in 2001. Before moving to the U.S., he was the founder and head of research at the esteemed Argentine equity research firm, Buenos Aires Trust Company, from 1991 until 2001. Prior to his arrival in Argentina, he worked in London beginning in 1985 as a corporate finance and equities analyst and as a freelance consultant on the restructuring of the securities industry. He holds a degree from the Royal Melbourne Institute of Technology.


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