Rare Earth Warning: Is the Gold Rush Over?

 |  Includes: MCPIQ, REMX
by: Jim Trippon

Just a month ago I predicted a global "Gold Rush" in the race to discover new sources of rare earth metals. Since then, America's main players in the rare earth game Molycorp, Inc. (MCP) and Rare Element Resources Ltd. (NYSEMKT:REE) have shot up in value. Molycorp is up more than 32 percent and Rare Element Resources is up more than 40 percent. But both are off their highs, and it has been a very volatile ride for investors. The question now is whether to stay invested for the long run, or take the money and run.

Is the Gold Rush Over? Rare Earth WarningClick to enlarge

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It is important to recap the background on this story. Rare earth elements are a family of minerals crucial to the production on high-tech goods. They are essential for the powerful magnets used in wind turbines. They are also crucial to the manufacture of batteries used in electric cars. And, some rare earths are essential to transistor and chip makers.

Rare earths are at the heart of modern products. But China currently has a 97 percent monopoly in the field. China's hold on the rare earth industry wasn't a problem until this year. During a bitter dispute between China and Japan over the ownership of remote islands in the South China Sea, things got very ugly. While diplomatic tensions and street demonstrations flared up in both countries over the issue, Japan claimed that China had suddenly cut off deliveries of rare earths.

China said that wasn't true. But in the ensuing confusion, China did cut global export quotas on rare earths for 2010 by a stunning 40 per cent. Then the US got into the fray during an angry dispute with China over currencies. Suddenly there were complaints that Chinese shipments of minerals to the US had been cut off. Furious politicians claimed that China was using its rare earth monopoly as a weapon.

As October came to an end, Germany also claimed that it had been cut off from Chinese rare earth shipments. Was China blackmailing the world? Not really. The Chinese simply said they had filled their export quota for the year.

Will Rare Earth Metals Become Rarer?

As the furor over China's clampdown on rare earth shipments continued, an ETF hit the market to take advantage of the scramble. That spiked stocks even further. The Market Vectors Rare Earth/Strategic Metals ETF (NYSEARCA:REMX) claims to offer investors exposure to equities of companies engaged in producing, refining, and recycling "rare earth/strategic metals." It's important to note that REMX has holding among many miners that have nothing to do with rare earth minerals. The ETF's creator says:

49 elements in the periodic table are considered rare earth/strategic metals... Strategic metals are used in a variety of technologies including jet engines, steel alloys, wind turbines, flat screen televisions and cell phones. Rare earth metals, a subset of strategic metals, are a collection of 17 chemical elements that are essential in many of today's most advanced technologies.

The launch of the ETF did cause a spike in the stocks of rare earth developers and miners. But these remain highly speculative stocks. Unlike most competitors, Molycorp actually has a mine. Although it was shut down in 1999, the company is now racing to reopen the facility. Is rare earth mining a wise investment at today's prices?

Molycorp is now valued at almost $3 billion. It has no income – only expenses, and potential profits. With no P/E multiple as a guide, this is clearly something of a gamble. Stocks of other rare earth resource developers appear to be equally speculative, but there is much less information about their ability to deliver the resource.

Questions and Answers From China

Hilary Clinton, the US Secretary of State, has pushed the rare earth issue to the top of the agenda. A few days ago she called on America and its partners to reduce their dependence on Chinese rare earth production. And on Saturday, China pledged that it would not withhold the crucial minerals from the world market. That should cool speculative fever for a short time. But China did not promise to increase its quota for 2010. That means possible shortages this year.

In fact, China long ago told the world to develop alternate rare earth sources. The Chinese intend to reserve their own rare earth stockpile for internal consumption. To be fair to Beijing, this is not an aggressive move. Cutthroat competition by rare earth miners in China cut prices so steeply over the past decade that mines like Molycorp's old Mountain Pass mine simply couldn't compete and they closed own.

As a result, the Chinese gained a world monopoly but not a very profitable one. The Japanese took advantage by stockpiling huge amounts of raw minerals, to be refined and manufactured only in Japan. As the globe's sole supplier, China suddenly saw itself at risk of running out of rare earths. The metals are important to China's strategic goals and that is why reduced export quotas were decreed by Beijing. Since then, rare earth prices have risen sharply.

The Bottom Line

At this time of chaotic change, it is hard to make any accurate prediction about the true value of raw or refined rare earth resources. New sources have been found in the US, Canada and Australia. There is the possibility of long term oversupply as a result of the current scramble to develop new mines.

Keep in mind also that rare earths are not really very rare. But they are hard to refine. It is challenging to separate trace elements of minerals from large amounts of ore in an environmentally safe way. Production costs will be high.

All of this means that the profit and loss potential of new rare earth ventures is very uncertain. As tensions with China ease, the frenzy over rare earth metals may cool. My advice is to take profits if you invested in the field when I wrote about it last month. If you don't have a position in rare earth minerals, I would advise extreme caution as these stocks test their peak values.

Disclosure: No positions