Seeking Alpha
Growth at reasonable price
Profile| Send Message|
( followers)  

Short seller Jim Chanos is well known for his negative assessments of China, especially Chinese real estate. One of his more colorful expressions about China's economy is "the Chinese are on a treadmill to Hell." We're sure the Chinese don't mind criticism from Chanos – or anyone else – as long as it convinces as many non-Chinese as possible that China has massive problems and represents no threat. From that point of view, kudos to Chanos.

Unfortunately, that expression really applies to the West, and to the U.S. in particular. Step back and look at the amount of money we continue to pump into our economy. Look at the national debt as it surpasses $14 trillion – with a t. Look at the multibillion-dollar deficits that we now battle to bring under control.

Billions of dollars continue to flood into our economy, courtesy of the Fed's program of quantitative easing, but look at the results. Last month an additional 50,000 were newly employed, a number not significantly different than zero. If anyone actually got a job – great. Yet with current expectations of economic growth now around 2%, the unemployed continue to hold a very short straw. With productivity gains averaging about 2%, that means the economy can achieve the current growth rate without adding any jobs – never mind the increases in the population which in time will add to the unemployment rate.

The employment data weren't the only worrisome figures. There's an array of troubling statistics, ranging from manufacturing to consumer sentiment to housing. In fact, consumer sentiment is the most "fuzzy" of all the data sets, but it really does set the tone. Consumer spending represents 70% of our economy, and until that segment improves, it's difficult to make a case for a stronger economy.

Having said all this, we must admit that the stock market – despite its recent skid – seems to be in pretty good shape.

Or does it?

Take a look at the following chart.


(Click to enlarge)

This is a chart of the S&P index going back a decade. But it's priced in Australian dollars!

Its resemblance to the Nikkei Index can't be denied. It might even be worse. The rallies are feeble, the declines are brutal.

We don't want to get too carried away with our bearish rant – but when you look at the employment figures and other data, they don't make for cheerful historical parallels. After all, it was in the early 1930s that Hoover decided that the way to prosperity was balancing the budget. Need we say more?

Look at the chart again. First, note that this chart, dismal as it seems, does have a positive connotation – or at least at first blush a positive connotation. It certainly suggests a deeply depressed dollar, which explains a paradox of the current U.S. stock market. Those U.S. companies doing business abroad have done fairly well. That's because all those profits are converted back into dollars from other, rising currencies. That means a tremendous boosts to profits, which translates into a stronger market. But how long can that continue?

That question actually doesn't revolve around monetary policy – because how much choice does the U.S. government have if all the money in the world just keeps us marching in place? Or, to be more precise, if it just keeps us from sliding further downward. Since the beginning of the century, the average real household income of Americans has declined about 10%. Yet the printing presses continue to work overtime.

But all the paper money in the world cannot make more oil or more copper or more titanium – though it will make all commodities more expensive. And that is why our average real income continues to fall despite all this money.

So the real reason why the S&P (and virtually everything else American) is depressed compared to the Australian dollar and other resource currencies and countries is because we simply don't have the resources. And without those resources, our standard of living has to go down.

When you're in an economy in which a $35,000 household income is considered well above the poverty line, but it takes $100 a week at the pump to transport the family, you have problems. (In addition to the "oil tax," copper, silver and other necessity metals have gone up dramatically, despite weakened demand in this country.)

Of all commodities, Americans focus on oil – and for good reason: It's the commodity we consume the most of, and we're heavily dependent on foreign oil sources. But in the resource field, the chain is only as strong as its weakest link. Ultimately, we have to focus on what is scarcest.

And we have to change the way we think about scarcity. There's too much emphasis on analyzing individual resources rather than considering related packages of resources. "Scarce" means whatever resource takes the most other resources to obtain. In any closed system (and the Earth as a whole is the ultimate closed system) any critical resource becoming ever more scarce is enough to sink the system – or at least to dramatically change the system into one in which material wellbeing sinks or population shrinks.

In short, the scarcity of oil is connected to the scarcity of silver, copper, rare earths - even the transition metal zirconium. And the more research we do into metal scarcity, the more concerned we become. Lately we have been ever more concerned about rare earths – not because they are so scarce, but because they are so difficult to produce and because there are so few concentrated deposits in the world. And those that do exist seem to be getting very short shrift.

The two most significant non-Chinese deposits of heavy rare earths – which are the ones that really count because they are needed for magnets that are used in everything from wind turbines to defense equipment – are in Canada. One is Avalon Rare Metals (AVL); the other is Quest Rare Minerals (QRM). These are small companies, with a combined market value of about $800 million, which means most mutual funds can't even look at them. They're also unabashedly speculative investments.

But as sources of rare earths, they may be critical. Avalon controls the Nechalacho Rare Earth Element Deposit in Canada's Northwest Territories. This strike is believed to contain not just REEs, but the heavy rare earths (HREEs) like dysprosium that are vital in the creation of ultra-strong industrial magnets. Quest has five REE sites in Eastern Canada, including Strange Lake, Misery Lake and Plaster Rock.

The bad news: in our opinion, it would take an industrial effort on the level of the Manhattan Project to make these exciting finds truly productive before the REE crunch hits us for good. Finding rare earths are only a small part of the process of turning the ore into usable materials. Separation, refining, fabricating all take huge capital investments. And we haven’t even mentioned the human capital – the engineers and miners - of whom there is a deadly dearth in the American labor force.

As a result, absent massive government intervention, these heavy rare earths are unlikely to find their way into products for another decade or so. In the meantime, we must rely on the Chinese, who do have the necessary skills and equipment. You just can’t make this stuff up.

The Australian Iluka Resources (OTC:ILKAF) is another industrial miner, but focused on zirconium and titanium instead of rare earths. The calculus around zirconium is very similar to that of rare earths. And with zirconium prices rising from $340 a metric ton in 2003 to $2000 in 2011, Iluka is poised to meet an enormous, growing, and unmet demand.

In the end, we feel investors should choose resources over currency (except for gold and silver which remain the first-choice currencies). Monetary policy can't solve every problem, and U.S. monetary policy is far more constrained than it was a decade ago. The dollar cannot decrease forever. At some point, the declining dollar will raise bond yields, and then the treadmill will really begin to accelerate and tilt even further south.

Source: The Rarest Rare Earths on Earth