The Rare Earths Bubble Is Coming Back

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 |  Includes: AVL, MCPIQ, QRM, REE, TAS
by: Simit Patel

Inflationary monetary policy is the story of the world these days, as it has been for the past 11+ years -- or for the past 40 years, if you take a broader look at money supply. But the past 11 years is when money supply has really gone out of control, fueling a new age of bubbles: dot com, housing, commodities, cleantech, rare earths, uranium, dot com again, and likely more to come.

For the astute investor alert to what is happening and experienced enough to avoid getting caught up in the emotions of volatility, this constitutes an enormous opportunity to invest in bubble after bubble in a short amount of time.

Thus far in 2012, it seems as though rare earths may be gearing up for another phase of rapid appreciation, as many of the stocks in the sector are up well over 20% thus far in the year. Fundamentally, the market is being driven by a strong supply/demand imbalance, as alternative energy sources such as solar, wind, and nuclear are particularly dependent upon rare earths -- and their usage is only growing as oil becomes increasingly expensive and scarce.

This is the kernel of truth that can attract an irrational bubble enabled by aggressive inflationary monetary policy. Moreover, China is capping exports of rare earths, a move deemed significant enough that the US, along with Japan and the European Union, are filing a complaint with the World Trade Organization regarding China's policies. The chart below shows how some rare earth stocks -- a rather small sector -- have fared this year:

right click to enlarge

Here's a quick look at the companies in the chart above, and my thoughts on them:

Quest Rare Minerals (NYSEMKT:QRM). This is the only rare earths company thus far that I've invested in, taking my first position in December of last year. I took this position after attending the San Francisco Hard Assets Conference and meeting with the staff of QRM; I was impressed with them, as they struck me as smart people worth investing in. I'm a people person first; all of the stocks that I'm most heavily invested in -- Tanzanian Royalty (NYSEMKT:TRX), McEwen Mining (NYSE:MUX), and Uranium Energy Corporation (NYSEMKT:UEC) -- are because of their management.

I was also swayed to invest in QRM because an investment analyst I admire deeply (who prefers to not be named) and who is much, much more familiar with the science of rare earths than I am spoke very favorably of QRM. I also am more interested in investing in heavy rare earths rather than light ones, and QRM satisfies that desire. QRM's market cap is currently just over $173 million.

Molycorp (MCP). Molycorp was the poster child of the rare earths bubble in 2010 and 2011, and it could be regarded as the safest way to play rare earths this time around as well: the firm has positive earnings, a P/E ratio of around 23, and a market cap of 2.42 billion -- making it nearly 10X or more the size of the other companies included in this list. The company is also taking steps to become more vertically integrated via acquisitions. Because of the complexity in extracting rare earths and integrating them into products, vertical integration can be especially beneficial, and thus I'm inclined to view this strategy favorably.

Avalon Rare Metals (NYSEMKT:AVL). Another heavy rare earths explorer, Avalon has over $60 million in current assets and no long-term debt. According to its latest investor presentation, Avalon should enter production by 2015. I think this will put it ahead of QRM, a fellow Canadian rare earth miner, although I like QRM's mining resource better. Avalon currently has a market cap of just over $287 million.

Rare Element Resources (NYSEMKT:REE). REE has the notable distinction of focusing on rare earths AND gold. The stock did manage to trade above $16 during last year's rare earth bubble; it's currently trading at $6.12. The company has begun testing separation of rare earths that it has mined from its project in Wyoming, USA. Separation is a larger challenge with rare earths, and how the company fares here will determine its economic potential as well as its potential customers. The stock is up over 88% on the year, which makes it the best performer of the ones listed here by a fairly wide margin. Of course, I'm usually reluctant to buy stocks that have had such sharp moves up, and that applies here as well; I'll need a particularly sharp sell-off before I can consider jumping on board. REE's market cap is currently just over $270 million.

Tasman Metals (NYSEMKT:TAS). Tasman is the smallest of the stocks listed here, with a market cap of just over $143 million -- and this is after appreciating nearly 60% on the year, second amongst the companies on this list. The company is focused on projects in Scandanavian countries, which may provide investors with a unique opportunity to secure some jurisdictional diversification. Production is currently targeted to start in 2016. This company is a little too small for the way I personally want to invest in rare earths, but if a sharp enough sell off occurs, I could find it worth re-visiting.

Ultimately I find all the companies here worth monitoring and potentially investing in, and I've added them to my watchlist accordingly. Because I'm a bit out of my comfort zone when it comes to rare earths -- my focus is much more on gold and uranium stocks, as my articles on SeekingAlpha can attest -- I don't think I'll be investing too heavily in this sector, and will have a strong preference towards meeting management prior to investing.

I'll certainly be keeping an eye out for these companies at the upcoming hard asset conferences I plan to attend in New York, Chicago, and San Francisco later in 2012. I do plan on holding on to my position in QRM for a while -- until either I believe the bull in rare earths has come to an end or if price appreciates too quickly and is at risk of collapsing.

Disclosure: I am long QRM, UEC, TRX, MUX.