It's hard to believe that just 3 years ago rare earth elements (REEs, hereon) had just completed a several hundred percent rally that took their prices into the stratosphere. The catalyst: China threatened to cut off the West, and there are virtually no REE producers outside of China. Furthermore, the two producing companies - Molycorp (MCP) and Lynas Corp. (OTCQX:LYSDY) produce the less critical REEs cerium and lanthanum The most important REEs such as dysprosium, europium, terbium, neodymium, and yttrium are all almost exclusively produced in China.
The possibility that companies would have trouble procuring elements essential to their production led them to scramble to obtain stockpiles, and this sent prices soaring.
In the end, the Chinese didn't stop REE exports, and as a result Western companies have been sitting on large stockpiles and using them up as market prices have fallen dramatically. Furthermore, despite continued threats from China that they will restrict REE mining (i.e. a crackdown on illegal mining) and exports to the West, the bear market has continued.
Just how bad has it been? The following table shows the current prices of some of the more important REEs in their oxide forms along with their 2011 peaks. I have also included their 2008/9 bottoms just so investors get an idea of the magnitude of the bull market. This last data point shows that the pain may not be behind us in REE prices, as many of these elements are still trading at several multiples of their 2009 bottoms. All amounts are in USD/kg.
|REE Oxide||Current Price||2011 Peak||2008/9 Bottom|
The moves we saw from 2008-2011 in some of these REEs is uncanny, and it becomes more unbelievable if you consider the prices of some of these elements at the turn of the century. For instance, dysprosium traded at just $7/kg.
So it shouldn't be surprising to anyone that prices have experienced such a major correction. However, the bull market is still intact as the demand for REEs in clean energy and defense applications continues to rise rapidly while supply has not. The question is a matter of "When?" not "If?" we will see another up-leg in the prices of REEs.
Now That the Hot Money Is Gone Follow the Smart Money
As you can imagine, the hot money has left the REE space, and it has been gone for quite some time now. The most popular stocks from the 2009-2011 bull market in REE stocks have fallen precipitously:
- Molycorp fell from $70/share to $2/share.
- Lynas Corp. has fallen from $2.50/share to $0.13/share.
- Tasman Metals (NYSEMKT:TAS) has fallen from $6/share to $1/share.
- Quest Rare Minerals (NYSEMKT:QRM) has fallen from $8/share to $0.20/share.
The list goes on but the point is made - investors have abandoned the sector.
But the smart money recognizes that the bull market remains intact, and we can see this as the shares of some REE companies are showing signs of bottoming out.
Those who have stuck with the sector have learned a couple important lessons and have started to differentiate between companies. This is a positive sign, as during the bubble phase investors were indiscriminately purchasing companies because they were REE companies.
Not All REEs are Created Equal
First, investors have learned that not all REEs are created equal. We can see this in the prices of the major REEs above, some of which are trading substantially higher than their 2008/9 lows while some are not. We further recognize that the West has a decent supply of a few of these REEs - predominantly cerium and lanthanum - from companies such as Molycorp and Lynas. While most of the supply of these metals still comes from China, the Western world does a good job of supplying cerium whereas it produces virtually no terbium, yttrium or dysprosium.
Furthermore, some REE applications have begun to stand out as critical. For instance, REE investors are very much aware of the rising demand for neodymium-iron-boron permanent magnets (Nd2Fe14B), which are made with neodymium. These are essential for manufacturing hybrid and electric cars. Recently, manufacturers of permanent magnets have been adding small amounts of dysprosium and terbium, as these elements allow the magnets to withstand higher temperatures without losing their magnetic quality.
Finally, investors recognize that the U.S. government and the E.U. are naming a subset of REEs as critical. This list includes terbium, dysprosium, neodymium, yttrium, and europium.
As a result, investors have lost interest in companies that have deposits containing mostly cerium and lanthanum. Thus, investors shouldn't be surprised that stocks of companies such as Molycorp, Lynas, and Rare Earth Elements have not yet found bottoms (Molycorp, of course, has additional issues with negative cash-flow and a lot of debt).
Rare Earth Elements are Expensive and Complex To Extract
One of the bear arguments is that REEs aren't quite as rare as the name suggests. But the issue is less about the actual quantity of REEs in existence as a percentage of the total material that comprises the Earth's crust and more about the cost of extracting, and more importantly of processing them. REEs are found in clusters and for the most part REE ore is separated one element at a time. This is incredibly costly and it requires a lot of technical knowledge.
So over the past couple of years, several of the darlings of the 2009-2011 bull market released PEAs and for many of them the results aren't pretty. The problem isn't that they don't have the resources. Rather the cost of extracting them is far too high in the current market environment for any rational corporation or individual to consider financing them. Take Quest Rare Minerals, which boasts that it has the biggest HREE deposit outside of China. According to the PEA, the mine will generate $758 million of revenue on $357 million in costs. But REE prices have fallen substantially and the project's operating margin is paltry, if it isn't already negative. Now, if we couple this with the company's initial capex estimate of $1.63 billion, we see that the largest heavy REE project in the West is simply not economical.
Now, if REE prices experience another 1,000% gain, the project becomes interesting once again. But this could take years, and the companies that are going to benefit from the increase in terms of cash-flow generation are the companies that are moving forward now, not after the next bull move. So maybe Quest will be a juggernaut in the REE space in 15 years, but we could see another 3-5 years of relative inaction, and this is why the biggest HREE project in the West is valued at just $14 million.
What Do The "Winners" Have In Common?
I have identified four companies in the space that have made clear bottoms and that are trading significantly higher than their lows for this bear market move. They include:
- Northern Minerals (Trades on the ASX under the ticker (ASX: NTU))
- Ucore Rare Metals (OTCQX:UURAF)
- Tasman Metals
- Texas Rare Earth Resources (OTCQX:TRER)
Granted, these stocks are all down substantially from their highs, but as we can see from the following charts they have made bottoms in the past year or so.
(Source: Google Finance)
Ucore Rare Metals
Texas Rare Earth Resources
Now, compare these with some of the charts of companies that have projects with too much exposure to the less appealing REEs and those with projects that are going to be expensive to develop. One chart that I am including here is for Avalon Rare Metals (NYSEMKT:AVL), which I haven't mentioned yet, whose Thor Lake Project suffers a little from each of these issues.
Quest Rare Minerals
Avalon Rare Metals
While the winners are trading at least 50% above their lows for the bear move, the "losers" are trading at or near the lows.
So why are investors starting to warm up to the first four companies, whose flagship projects probably aren't economical given the recent weakness in REE prices?
I cite the following reasons.
1: Heavy on the Dysprosium
Dysprosium oxide prices have taken a nasty tumble as of late, but REE bulls seem to have singled this element out as fundamental to a successful REE project. Only about 2,000 tonnes of the stuff is mined each year, and virtually all of it comes from China (Molycorp's and Lynas' dysprosium production is negligible). The reason for this is the aforementioned fact that dysprosium is substituting some of the neodymium in neodymium-iron-boron magnets due to the fact that its addition to this alloy enables magnets to withstand higher temperatures without losing their magnetic quality. Dysprosium also makes for a stronger magnet. While there are other REEs that have this quality such as holmium, there simply isn't enough supply at the moment to make holmium magnet research viable in the commercial realm.
Each of the four companies that I have singled out as "winners" have a lot of dysprosium at their flagship projects. While this exposure has fallen given the particular weakness in dysprosium prices, investors don't seem to care - they want dysprosium exposure.
The four projects in question will all likely get at least 25% of their revenues from dysprosium. Northern Minerals stands out as the "purest" dysprosium producer: according to its PFS, over 60% of the revenue from its Browns Range Project in Australia will come from dysprosium. Even with the recent underperformance this number is probably close to 50%.
While having dysprosium isn't a sufficient condition to make it onto the "winners" list (e.g. Great Western Minerals' (OTCQX:GWMGF) Steenkampskraal Project in South Africa has a high percentage of dysprosium as well), it is a sufficient condition.
It's risky enough trying to step in front of a relentless bear market without worrying about political risk, and so investors have been focusing on companies with projects in safe mining jurisdictions. Both Norra Karr (Tasman) and Browns Range are in locations that the Fraser Institute Mining Survey ranks in the top 10 out of over 112 countries, states and provinces (Sweden (#1) and Western Australia (#6), respectively).
Ucore's Bokan Project is in Alaska, which came in 21st, but this is only because some executives surveyed are concerned about a lack of infrastructure and excessive environmental regulation. The former is not a major concern given the mine's proximity to a city - Ketchikan - and the latter risk is mitigated given the U.S. government's interest in the Bokan Project, given the importance of dysprosium and other REEs to national defense.
Texas Rare Earth Resources' Round Top Project is in Texas, which isn't on the survey. However, the company's Chairman Anthony Marchese told me in an interview that the company has an advantage in dealing with the Texan government rather than the federal government and the EPA. The Round Top Project is also near El Paso so it has significant infrastructure, labor, and intellectual capital (from the University of Texas at El Paso) at its disposal.
In short, each of these companies' flagship projects are in the least risky mining jurisdictions in the world, and where there is the slightest hint of heightened risk there are mitigating circumstances.
3: Moving Beyond The PEA
So this doesn't apply to Molycorp and Lynas as producing companies, but three of the four companies in question have done significant work beyond the PEA. Texas Rare Earth Resources is the exception, although its PEA is the youngest of the 4 and so we can cut them some slack. Furthermore, the company's valuation is about a fourth of the valuations of the other 3 ($15 million vs. valuations in the $60s million).
So for the other three companies we have seen substantial work done beyond the PEA which means that people with deep pockets believe in their projects. The companies are all doing extensive metallurgical research in order to minimize the cost of processing and separating these complex minerals, and in fact Tasman recently announced that it can achieve high recovery rates without flotation and its hydrometallurgical REE oxide precipitation requires less sulfuric acid, which will save the company money on processing. Furthermore, Northern Minerals recently released its PFS, which puts it on track for 2016 production, assuming it can secure financing. Finally, Ucore has substantially heightened its chances of getting pre-production financing from the state of Alaska, which recently passed legislation allowing the Alaskan Industrial Development and Export Authority to loan $145 million to Ucore at its own discretion. Note also that both Tasman and Ucore are working towards producing PFSs.
The fact that these companies are able to raise money without destroying their respective share prices indicates investor confidence, and it suggests that these projects have the highest probability of being built.
4: Relatively Low Capex
The initial capex estimates for these companies' projects is about $300 million, with the exception being Ucore's Bokan Project, whose initial capex is about $220 million. While these are just preliminary estimates (except for Northern Minerals' Browns Range) they are achievable figures. Granted, I don't think that they could raise what they need given what has happened to dysprosium prices, but if and when prices rebound investors will be more willing to give money to these companies than to, say, Quest Rare Minerals, which as we have seen needs $1.63 billion.
The Bottom Line
The REE market is lousy right now, but this is a sign that we are closer to a bottom than we are to a top. The market is so bad that it is difficult to point to a given REE project and say that it is economical, and unless we use optimistic production cost figures, we probably can't at current REE prices. But the long-term demand for these elements is still present, and it is growing rapidly despite the fact that there is virtually no supply for the most critical of these REEs coming from outside of China.
This makes those projects that can supply the critical REEs vital, especially given the escalation of political unrest and trade restrictions we are seeing throughout the world. China is exporting REEs now, but a trade war can stop this. So can a reduction in supply stemming from a Chinese clamp down on illegal production.
With this in mind, now is the time to start looking at REE investments. But while there are dozens of choices out there, most of them aren't very attractive. They either produce the wrong REEs or they simply have lousy economics.
But there are four that stand out in this market. We have seen that they share qualities such as low capital costs, low-risk locations, project development, and heavy exposure to dysprosium - the most compelling REE from an investment standpoint. In addition, each project has its own unique appeals:
- Northern Minerals' Browns Range has the highest dysprosium exposure and it is the only project of the four to reach the PFS stage. If dysprosium prices improve soon, Browns Range will be the first in production.
- Tasman's Norra Karr is in the best mining jurisdiction in the world with a massive resource that can supply Europe for over 40 years. The company's PEA uses a dysprosium oxide price that is higher than the market price, but management has assigned no value to the rarest REEs which virtually have no market. The upside is tremendous.
- Ucore's Bokan is the smallest deposit of the four, but it is the only one that has attracted intensive government interest, and it is the only project that has come close to securing financing.
- Texas Rare Earth Resources' Round Top potentially has a 100-year deposit and it has very low projected production costs. While it is behind the other three, you are compensated for taking the added risk - the company is valued at less than a fourth of its three peers.
Depending on what you are looking for as an investor, one of these companies may be more appealing than the rest. But they all stand out as having received the approval of the bottom fishers, and I am confident that they will stand out amongst their peers as the bear market comes to an end and as a new bull market commences.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in TAS, UURAF, TRER over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may initiate a long position in Northern Minerals in the near future.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.