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The Impact of the Japanese Earthquake on the Demand for Rare Earths in the first 1/2 of 2011

|Includes:GWMGF, LYSCF, UURAF

In the short term the biggest problem for the Japanese economy is to provide immediate humanitarian relief to the victims of the earthquake. Cost will, of course, not be a factor in rescue and relief efforts.

However in the long term the very largest problem for the Japanese industrial economy will be the sudden onset of the need to, in the best circumstances, redistribute and in the worst to allocate and prioritize the supply of electricity between civilian and industrial demand.

I don't know how much of Japan's national electricity production capacity has been destroyed, but even if there is spare capacity it remains to be seen when the grid in the affected area can be restored.

It also remains to be seen how much of Japan's industrial capacity has been impaired and which particular industries may have been affected.

As long as the emergency lasts there will be no need and perhaps no easy way, logistically, in any case to continue either just-in-time or long term deliveries of non fuel or non food raw materials.

Theoretically Japan will want to bring its export industries back up to speed as soon as possible so as to resume full economic life as soon as possible. Practically, however, some industries will need to slow down so as to allow others to get logistical priorities for humanitarian reasons.

Japan is China's largest customer for rare earth metals and alloys, but processing such materials is energy intensive, so that such processing may be reduced or even eliminated this year until the essential economy is restored.

I am going to guess that deliveries of rare earth metals and alloys to Japan will slow dramatically in the next quarter at least, if not longer. Although Japanese trading companies will continue to buy and now stockpile them they will not simply accumulate them for an indefinite period.

This means a short term increase in the supply of these materials since the production of them is mostly in an unaffected China. If the law of supply and demand is still operating in the real world this should mean a short term decrease in the price of the critical rare earth metals.

I note, finally, that last year China exported only 10% of its production of the critical rare earth metal, dysprosium, as a metal for others to alloy and fabricate products. If I were a Japanese end user or trading company or one of the same in Korea I would try now and buy as much dysprosium as I could and take delivery outside of China for future demand.

The rare earth production industry's customers are overwhelmingly in China and Japan. Any impairment of industrial production in either country will have a major impact on global rare earth prices.

Investors should focus on those rare earth ventures that can produce outside of China the most critical rare earth metals such as dysprosium and terbium and europium. There are ample deposits of the lighter rare earths in development, and thus no further need to worry about the supply of the light rare earths.

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

Stocks: IQ, LYSCF, GWMGF, UURAF