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Michael Filloon, Split Rock (378 clicks)
Oil & gas, small-cap, research analyst, growth at reasonable price
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Rare Earth Elements or REEs seem to be the newest big mover on Wall Street. Although most have heard of them, they do not know what their use is. The best way to identify them is by going back to chemistry class and looking at a periodic table. Here is an easier introduction.

Avalon Rare Metals Inc. (AVL) has seen a large appreciation of market cap over the past year, but this may just be the beginning. Avalon has a well diversified set of rare earth holdings. All of their projects are 100% owned.

The Thor Lake holding is delineated into two separate mines. Nechalacho has several heavy rare earths such as tantalum, niobium, zirconium, haffnium, and gallium. The North deposit contains berylium, lithium, gallium and niobium. Separation Rapids has lithium. Lilypad Lakes has tantalum. Warren Township has anorthosite and East Kemptville has tin-indium.

Avalon's Thor Lake deposit at Nechalacho had a positive prefeasibility study done in 2010. The company has invested $27 million Canadian since 2005. The bankable feasibility is underway and is fully financed. This should be completed by 2012. This large resource could be quite profitable as it has a 20%-28% heavy earths. Recovery process at bench scale, with pilot plant in progress. Production start up is planned for 2015.

When comparing the Nechalacho to other areas with large concentrations of rare earths, we see a very large concentration of the heavy rare earths. Mt. Weld in Australia, Mountain Pass in USA, and Nolans in Australia all show a much smaller concentration of heavy rare earth elements. Heavies constitute 22.2% of rare earths in Nechalacho as opposed to the high of 3.13% at Nolans to the low of .39% at Mountain Pass. Although this gives a limited comparison, it shows the heavy rare earths are in much more limited supply.

Interestingly there has been a much larger demand for rare earths over the past few years, and nothing shows it slowing down. At the same time China has begun to decrease exports. Export quotas will be reduced by 35% in the first half of this year. There has also been an increase in media coverage for this group. The REE groups have benefited by posting a 300% increase in 2010. Molycorp (MCP) has done a great job of attracting media coverage and with is has seen a large jump in share appreciation. Molycorp's magnet alloy joint venture with Hitachi Metals also added investor interest. The company also announced expansion plans to 40000 tpa TREO and new equity finance. Looking at Chinese REE exports from 1990 to 2011, show a decrease in overall exports, but a very large jump in the value of those exports. It shows price increases of REEs.

As of January 19th of 2011, MetalPages.com listed the prices of these rare earths:

Light Rare Earths
Lanthanum Oxide 99% min- $61-$63/kg (Rechargeable Batteries)
Cerium Oxide 99% min- $66-$68/kg (Catalyst, glass, polishing)
Praseodymiun 99% min- $89-$92/kg (magnets, glass colorant)
neodymium 99% min-$89.50-$92.50/kg (magnets, lasers, glass)
samarium 99% min-$54-$55/kg (magnets, lighting, lasers)

Heavy Rare Earths
Europium Oxide 99% min- $620-$640 (TV Colour Phosphors: red)
Terbium Oxide 99% min-$610-$630 (Phosphors: Green, magnets)
Dysprosium Oxide 99% min- $285-$305 (Magnets, Lasers)
Gadolinium Oxide 99% min- $53-$56 (Magnets, Superconductors)
Yttrium Oxide 99.999% min- $72-$77 (Phosphors, Ceramics, Lasers)

Two of the REEs listed are of particular interest. Pricing with respect to dysprosium and neodymium has been quite bullish since December of 2009. Dysprosium is up over 300% and neodymium is up approximately 500% over this time frame. Demand is up significantly with many of the REEs, and this demand should continue for some time.

Magnets and electric motors or Neo magnets allow for a reduced electric motor/generator size and weight. This improves motor efficiency. Examples broken down by amount of REE used are:

Electronics- use small amounts (grams)
Hybrid electric cars- use one to two kilograms
Industrial air conditioners- use on average 500 kg
Wind turbines- use .6-1.0 tonne/MW
MRI machines- use 1-3 tonnes

It is safe to say, that some of the rare earths could see dramatic price increases. When looking at the cost savings with respect to reduced power consumption (up to 50%), and decreased size, consumers will be willing to pay higher prices for these advantages. 30% of these magnets are made from neodymium metal. Dysprosium and terbium make magnets heat resistant, which is becoming much more important in automotive applications. Many of the heavy rare earths are used in energy efficient lighting and display screens. A good example of production need are wind turbines. GE produces a 4 MW model that uses 2 to 3 tonnes of neo magnets. GE has additional plans to begin producing a 10 MW model.

Nechalacho is now the third largest deposit in the world with respect to niobium. It is used in high strength, low alloy steels. Use of this type of steel is expected to double in a the next few years. Bridge and ship building create demand. Niobium is just starting to be used in automobiles and the weight decrease increases fuel efficiency. $9 of niobium creates fuel savings of one litre every 100 kilometers.

Most zirconium production comes form zircon sands in Australia and South Africa. China currently imports zircon sands and is the only producer of zirconium oxychloride. This is needed to produce Zr rated metal. Consumption is increasing. It is used in nuclear reactor builds.

The Nechalacho mine will eventually produce 2000 tonnes per day, although it is expected to initially be a lower rate. Production of 10000 tpa mixed REE oxides for separation elsewhere. The market captures less than 5% of estimated 2014 total rare earth oxide global demand. Operating costs are estimated to be $267 per tonne. Cap ex estimate is $900 million for Nechalacho.

Currently there are no large scale rare earth separation capabilities outside of China. Building a 25000 tpa HREE plant would have an estimated cap ex of C$345 million. Sites are being reviewed for possible build.

The best way to determine if Avalon is a good investment is through comparison to other companies in the REE market. Avalon (AVL) has a market cap of 633 million; it has 4.298 million tons of TREO, which values their rare earth oxide at $147 per tonne. Arafura (OTCPK:ARAFF) had a market cap of $390 million; it has .84 ton of TREO, which values their rare earth oxide at $464 per ton. Quest Rare MInerals (OTC:QSURD) has a market cap of 281 million; it has 551 million tons of TREO, which values their rare earth oxide at $511 per ton. Rare Element Resources (REE) has a market cap of 502 million; it has .55 million of tons TREO, which values their rare earth oxide at $913 per ton. Molycorp has a market cap of 4.22 billion; it has 1.395 million tons of TREO, which values their rare earth oxide at $3025 per ton. It is obvious some of these numbers are skewed as Molycorp is in the production/expansion stage of their business and Avalon is in the development stage, but this does not change the value of the metal in the ground, and comparison to pears seems to show they are trading at a discount.

In Summary, REEs are an attractive trade based on the expansion of technology with the emphasis on renewable energy. Although many of these stocks are up an exceptional amount, this trade is somewhat like uranium. They trade very high on the idea that companies will pay much more then today's prices. An example is their use in steel creating a lighter car. The $9 of niobium saves a liter of fuel ever 100 km. The savings in one thousand km in month's driving would more then substantiate a major price increase of niobium. If investing in the rare earths, Avalon is attractive from two standpoints. The company has a very high concentration of heavy rare earths. Since these are more scarce price increases will be more likely here. Secondly, it seems to be a value when compared to REEs in the ground. I think any of the names mentioned here are a good trade, until the current trade ends.


Disclosure: I am long AVL.

Source: The Long Case for Avalon Rare Metals