How to Play Rare Earth Metals

by: Markos Kaminis

Rare earth dealing stocks took off this week, reviving a year-long climb. By Tuesday the popular press was well focused on the gains, as a report that China would be limiting exports of rare earth elements found the wire. At this point, investors are most interested in learning if it is too late to benefit, and we think we have uncovered a couple ways you still might.

In case you were unaware, rare earth elements are of strategic importance to our defense industry, and China has quietly amassed a 96%+ majority of the world's supply of the scarce stuff. We are talking about dysprosium (vital to clean energy), terbium, europium, neodymium, and yttrium. These are not household names, but the iPhone and other mobile phones, flat screen televisions, compact fluorescent light bulbs, and rocket guidance systems they are used in are, and clean energy initiatives involving wind turbines and electric cars will need them too if we are to seriously move toward energy independence.

Showing us how China will deal with the world in a future in which it becomes more important, the country has imposed criminal export taxes on these and less expensive rare earths like lanthanum and cerium, which are used in oil refining and glass manufacturing. The World Trade Organization has banned export taxes, but China has imposed them on these elements for the last four years - simply because it can. In some cases, materials that cost a few dollars a pound in China, cost $40+ elsewhere, due to the tariffs. That's called giving it to ya good where I come from. Imagine how China will deal with us when it is a more important military and economic power.

Dysprosium helps magnets retain their magnetic properties under extreme temperatures (for permanent magnets), which makes it important to clean energy industries. Its near complete current production in China, and the strong push for clean energy including within China, has some experts worried the limited supply of the resource could stymie development for five years or so. Because of this, along with China's unfair currency policy and low cost labor, alternative energy companies are basing operations in China, which nearly ensures the US manufacturing base will find no benefit from the shift toward energy independence. That's a bummer for President Obama and his big hopes to revive the Midwest.

The Chinese seem to have legitimate reasons for controlling supply, starting with their own burgeoning domestic demand derived from multiplying middle class development. It seems the strategic importance of the elements will ease legislative and regulatory restrictions that had helped to shut down US production previously, in favor of cheaper Chinese sources. However, for now, the demand/supply equation has been wildly swayed, and prices have rocketed. For instance, in 2003, you could get a pound of dysprosium for $6.50, though I don't know where. Today it runs upward of $132 a pound. Thus, capital is running to rare earth miners and companies whispering of moving some of their mining resources to rare earth production.

Thus, over the past month or so, a creeping of the rare earth stocks has shifted back into high gear once again. Molycorp (NYSE: MCP) has reinvigorated its year-long trend higher, rising 70% thus far in December alone. Rare Element Resources (NYSE: REE), another name getting plenty of attention, was up 14% Wednesday alone and is up 49% since the start of the month. This stock was less than $2 back in the summer, and now trades near $15! REE is a North American like Molycorp, based in Canada, and has operations in Wyoming. It mines gold and rare earth elements, so it is doing okay despite gold's lag... Trading volume was almost seven times normal Wednesday for this debt free company, and REE has been active this month raising money for E&P, since it can at will now.

If you are seeking exposure at less risk, you might try the Market Vectors Rare Earth Metals ETF (Nasdaq: REMX), though it is not a pure play on the squeezed resources out of China. The ETF was only up 7% Wednesday and is up 20% this month. General Moly (AMEX: GMO) was up 10% Wednesday, and is a development stage company focusing on molybdenum through a property in Nevada. It's a money loser and cash burner, but with prices on the rise and supply constrained, the economics of operation are changing for all of these companies.

"This move has all the components that a stock frenzy needs, as it includes China and a mysterious good that nobody understands."

This move has all the components that a stock frenzy needs, as it includes China and a mysterious good that nobody understands. The quick profits are sending capital into more speculative names as well, including stocks of companies that have little or no currently proven resources in the commodities of interest, but are prospecting hopefuls or at least people are saying they might be. The latter is implied by the movement in the shares of Qiao Xing Universal Resources (Nasdaq: XING), up 46% Wednesday to $2.71.

The company is a zinc and copper miner with resources in Mongolia, but is somehow finding frenzied capital interested from rare earth seekers. Whether something pans out or not probably will not matter to the traders pushing this stock up, when they pull the rug out from under you later. And it is probable also that unsophisticated investors in China are helping fuel the rise too, which makes for an unreliable support base.

Shares of China Shen Zhou Mining & Resources (AMEX: SHZ) has most of the hot keywords in its name, and so led all gainers Wednesday, rising 69%. This company also focuses on copper and zinc, but has mysterious properties in inner Mongolia that smell good to frenzied capital. Buyer beware, and take a close look at the company's 10K or Chinese facsimile to see if it has rare earth possibilities. We are guessing by the movement Wednesday that a few investors might have discovered this to be true, or were saying so anyway.

We went through the last 10K issued for March-end and saw only copper, zinc and fluorite within its portfolio, and one location indicated further exploration might find more minerals, but did not expand as to whether those would be more of the same or something magical. So, is it speculation driving the shares, or inside knowledge or unfounded rumors? Whatever the case, it's not enough to trade on from my perspective. And be careful if you find information in the latest 10Q that did not exist in the 10K issued for March, because this is China we're talking about, the land of legend.

Then there are companies like Avalon Rare Metals (AMEX: AVL), which have it all together. The company was formed in 1991, but changed its name in February 2009 from Avalon Ventures to Avalon Rare Metals (so you would better notice it). What I like best about it is that it makes everything even more mysterious by looking for the alien goods beneath a dark Canadian lake. This stock stopped taking part in the fun after a Monday morning spike higher, and though it may eventually dig up something, I'm not excited about it right now.

Australia based Lynas Corp. (OTC: LYSCF.PK) is a tiny company active in rare earth and other mining in Australia and Asia. Lynas' Australian shares (ASX: LYC.AX) gained about 8% Wednesday, while its ADRs in the US (OTC: LYSDY.PK) gained about 14% and are up 30% through December. A look at the company's website seems to indicate it has all the right stuff, and after reviewing comparable info from the US State Department's December Report, it appears to have relative importance. The company claims to have the richest deposit of rare earths outside of China, and the US State Department Report I checked seems to agree. Lynas expects to be first to market outside of China in Q3 2011, and I'm officially interested.

You can be sure that given the new economies of the sector, the big boys, those being Rio Tinto (NYSE: RIO) and BHP Billiton (NYSE: BHP), are paying attention to the ones worth noting. If you catch a whiff of who they're sniffing up, you might have a lead on which stocks make best long-term sense; and I'm talking about if they're not bought out. There are also going to be a bunch of worthless miners that might stumble upon an opportunity and create some millionaires in the process. This is an interesting place to prospect, but it's the most dangerous treading, so be careful. As for the group generally, the stocks have run up so much, and there is so great uncertainty (outside of this blog anyway) about which ones will really produce the key rare earths over the next five years, that I would look for a January pullback for the group broadly before considering long-term stakes using perhaps LEAPS. You might use the REMX ETF for that. Of the stocks, Australia's Lynas has my interest right now (I'm calling it a "Buy"), and Australia's other projects look promising as well.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.