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Mike Holt is a Senior VP, Wealth Management Strategist with The MDE Group, an innovative Wealth Management Firm located in Morristown, NJ that manages over $1 billion for corporate executives and other high net worth individuals located across the US. Mike's diverse background includes auditing... More
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  • TREM '11 -- Part One: The Challenges
    On March 22, 2011, I walked into a conference room at the Ritz-Carlton Pentagon City hotel, the site of the TREM ’11 Technology Metals for Energy & Security Conference.  I decided to attend this conference in an effort to better understand how the US government and American businesses were planning to address our dangerous reliance on imports of rare earth based materials, both for our critical national security needs, and for numerous advanced technologies that hold the key to the economic growth that we so desperately need. On March 23, I walked out of that conference room with heightened concerns regarding the challenges that such a public/private sector partnership presents, but an overall sense of optimism regarding a number of initiatives that were presented for our shared consideration. In this article, I will describe the challenges.
     
     TREM 11 Logo
     
    Although I didn’t notice beforehand any discernible pattern in the sequence of presentations on the agenda for the TREM’11 Conference, in hindsight it was clear that the perspective had evolved from one questioning why the government hadn’t done more to develop a domestic rare earth mining industry to one critical of excess government regulations and inefficient bureaucracies that served to hinder the development of a domestic rare earth mining industry – indeed, a domestic mining industry in general.
     
    This growing sense of enlightenment seemed to result from more than just the incremental insight gained from each successive speaker. After looking back at the agenda, the explanation for this became clear. The Conference began with speakers from representatives of various US Government Agencies and ended with CEOs of various rare earths mining companies. (Copies of most of the presentations, by the way, are also available at the IAGS TREM Center website.) Although the topics and backgrounds of the speakers for the intervening presentations were refreshingly diverse, the awareness that reducing our dangerous dependency on foreign sources of energy and critical materials would ultimately be the primary responsibility of the private sector was realized gradually, almost imperceptibly, until it was made obvious by the final speakers.
     
    This is not to say that the government, military, industry associations, trade groups, non-profits, NGOs, media and others can’t play a vital role in addressing our dangerous reliance on energy and critical materials from foreign sources, sometimes controlled by unreliable trading partners, and sometimes from parts of the world that are unstable and/or characterized by hostility toward the US and its allies. It is just that these efforts are more likely to succeed if they are supportive of businesses, and elicit the cooperation of the American public. For the most part, the speakers representing the various government agencies seemed to understand this, as they were already seeking to better coordinate their efforts among each other. Based upon the feedback they received at the TREM ’11 Conference, these improved communication/coordination efforts should eventually be expanded to also include businesses, investors, and consumers.
     
    What is the Proper Role of the Government in the Economy?
     
    However, there is still room for improvement in understanding the true nature of the issues facing us, and in some cases, the solution on the part of the government is less not more. For example, the CEO for one of the rare earth mining companies effectively stated something like this, “We’re not looking for handouts from the government. We would just like to eliminate much of the bureaucracy and red tape that result in excessive start-up times for a mining operation in the US.”
     
     TREM 11 Permitting Challenges
     
    To put this into perspective, Katie Sweeney of the National Mining Association pointed out that the Department of the Interior requires a fourteen department, SEQUENTIAL, review process before a mining company can even commence the scoping necessary to prepare an environmental impact statement. This adds about three months to the permit processing time. Furthermore, there are four such permitting processes required throughout the start-up cycle of a mining operation, each of which is subject to similar bureaucratic delays. In total, the permitting process in the United States can take seven to ten years to complete, and only then can the mine development process commence.
     
     
     Key Commodities Import Dependence
     
     
    Obviously, the greater the uncertainty, complexity, and time required for an attractive deposit to be converted into a viable mining operation, the less attractive such US mining operations are likely to be to investors, and the less likely such deposits will be developed within the US. Environmentalists and desert tortoises may celebrate these roadblocks, but this should be a great cause for concern among freedom loving people concerned about our economic and national security, who may also appreciate the importance of a domestic mining industry -- as well as a domestic manufacturing industry and many other job creating industries within the US, for that matter. For more information on this topic, visit www.mineralsmakelife.org
     
     
    Contribution of Minerals to US GDP
     
    Can’t Live With Them, but Can’t Live Without Them
     
    But, while many in the industry seemed to want the government to simply get out of the way, my initial concern was why the government hadn’t done more. This question loomed even larger after I listened to a presentation in the first session by retired Air Force Major General Dr. Robert Latiff, now Director of the Intelligence and Security Research Center at George Mason University.
     
    Dr. Latiff pointed out that the need to adopt new methods for assuring the timely availability of rare earth elements and other materials necessary to maintain national defense capabilities beyond the outdated reliance on the National Defense Stockpile first established in 1939 was presented to the Department of Defense as early as 2003. This is documented in a book titled, “Managing Materials for a 21st Century Military, ” which was authored by a National Research Council committee that he chaired. This two-page Report prepared in October 2007 provides a brief summary of the book’s conclusions, and indicates how the book can be ordered by those seeking more details. Dr. Latiff further explained that the steps necessary to transition the National Defense Stockpile to a total system approach known as the Strategic Materials Security Program was presented to the US Department of Defense in September 2010, but is still under review.
     
    NMAB Report
     
    I was left with the impression that Nero was clearly fiddling while Rome burned. It was obvious that something needed to be done years ago, and there was little or no time left to be pondering alternatives.
     
    Are There Substitutes, or Just Excuses? (Where is John Galt?)
     
    But, ponder alternatives is exactly what was being suggested in the next session by Robert Cekuta, who is the Deputy Assistant Secretary for Energy, Sanctions and Commodities for the United States Department of State. He is responsible for the United States global energy security policy. It then dawned upon me that perhaps the most important question regarding the danger posed by our reliance upon imports of rare earth based materials – namely, whether there are substitutes for rare earth elements that could be realistically developed on a timely basis to achieve our national security goals and our economic growth objectives -- remained largely unanswered. So, I asked Mr. Cekuta for his opinion in this regard.
     
    I was initially shocked by his response.  In his words, if there were no substitutes, then market forces already would have enticed private companies into the space. Did he not realize that, sitting in the seats before him were executives representing scores of rare earth mining companies? What possibly could have enticed them into this space? Would his answer be any different if the issue at hand was as pressing as a desert traveler’s immediate need for water, I asked? What good would it do to inform the traveler that there is no water, but there is hope that someday, someone may be able to produce a substitute? It wasn’t until later, when I had heard the comments made by representatives of the mining companies, and when it occurred to me that most had operations outside the US, that I appreciated his response that “mines won’t be opened unless they are profitable.”
     
     REE Global Supply Demand Balance
     
     
    What Will it Take to Make US Mines Profitable?
     
    I later developed a better understanding of Robert Cekuta’s remarks, but I still believe that there is a role for government, even if we must ultimately rely upon the private sector to engage in those activities for which it is better designed than the government. This is what led to my follow-up question to this same panel, but this time directed to Terence Stewart, the managing partner at the Law Offices of Stewart and Stewart, with a concentration on international trade matters and customs law. Currently, he is a Member of the Steering Group of the International Trade Committee of the American Bar Association’s International Law Section. In my notes, I summarized his presentation as follows: What happens when one country dominates supply of a commodity and then chooses to control the supply of that commodity for geopolitical purposes rather than for commercial purposes?
     
    Who better to ask: (1) whether it is possible to expel a country from the World Trade Organization if that country repeatedly fails to abide by the conditions upon which its admission was based; and (2) given the restrictions on actions that some might regard to be a foreign intervention into a matter under the sovereign control of another country, what measures can be taken to directly penalize the managers of corporations who harm corporate stakeholders by establishing operations in a country that is known to disrespect intellectual property laws and to engage in practices that are detrimental to free trade?
     
    Unfortunately, his answers were less than comforting: Once a country is admitted to the WTO, it would be nearly impossible to expel them, and it is virtually impossible to pierce the corporate veil. I am not an attorney so, for better or worse, I am not able to understand how things that make no sense make sense. However, I am aware that individuals are often held directly responsible for their actions in China, especially when it involves “state secrets” – which is not too uncommon since it is virtually impossible to avoid doing business in China with a company in which the state does not somehow maintain a stake. So, perhaps there is some comfort to be taken in knowing that ultimately at least one country’s intellectual property and stakeholder interests will be respected.
     
     
     Law and Policy of the WTO -  Table of Contents
     
    Unfortunately, the inability of our own government and judicial systems to ensure that market forces remain intact does little to ensure that we may rely upon such market forces to entice the private sector into establishing rare earth mining companies and related industries within the US.  Ironically, where government actions have been taken, they have often served to further impede a healthy industrial sector within the US.   The paradox is that markets have become so distorted by domestic and foreign government policies and interventions that it is hard to see a way forward without a need for even greater involvement on the part of the US Government. This may explain why retired General Gregory S. Martin, former Commander of the U.S. Air Force Material Command (AFMC), which is responsible for various activities necessary to maintain Air Force weapons systems, commented that we can’t just leave these issues to the markets.    Of the ten commands reporting to HQ USAF, AFMC is the largest in terms of funding, with an operating budget equal to 57% of the Air Force budget.
     
     
    Is There Hope for Change?
     
    Given the current state of affairs, General Martin’s assessment may be correct, but I think we can right the ship if changes are made within both the public and private sectors. Although government officials did not dwell on this topic during the conference, I suspect that the maze of regulations now faced by the mining industry as a whole were triggered at least in part by irresponsible actions likely taken by certain private businesses. But as private sector participants were quick to point out, punishing the entire industry with an extremely inefficient maze of regulations administered by overlapping regulatory bodies rather than efficiently prosecuting wrongdoers is not the answer.
     
    As for the private sector, the efficient allocation of capital to this space seems to require a more long-term strategic perspective on the part of downstream industries that rely upon rare earth based materials for the profits that they generate from their potentially higher margin products. I believe that such a vertical integration strategy, representing a private sector rather than a public sector initiative, is a better way to address the risk of further market manipulating activities on the part of foreign governments that seem to have only temporarily resulted in artificially low costs elsewhere.
     
    The response from the public sector should be to eliminate artificially high costs here in the US.  Although it may be tempting for the government to play a greater role – to fight fire with fire, so to say – such efforts often backfire. For example, there is some evidence, such as cancelled IPOs, which suggests that the recent launch of an array of new government programs and central bank interventions has introduced a level of confusion and uncertainty that makes it increasingly difficult for private sector businesses to raise needed capital, which is particularly vital to the development of mining companies. Increased government spending during a slowing economy may seem appealing on the surface, but could actually be quite harmful if it serves to reduce private sector spending and investment to an even greater extent.
     
    But, as indicated earlier, there is a very important role for the government to play here. We just need to identify what things are best handled by the public and private sectors, and to improve the relationships between the two to ensure that both remain healthy. I’ll talk more about this in Part Two.
     
    Aug 30 10:17 PM | Link | 25 Comments
  • Finding the Energy to Put Us on a Safer Road to a Brighter Future
    In my previous blogs, I have attempted to demonstrate how concentrations of power and/or excess reliance upon a single resource can create dangerous disequilibriums not only within the context of financial markets, but within economic, social and political contexts as well. I also pointed toward the danger of excess debt and reliance upon debt to achieve the appearance of near-term stability, when in fact this may simply create even larger, long-term disequilibriums, especially when debt levels grow faster than levels of economic growth. I stated that many developed countries are currently faced with the dual challenges of both excessive debt and slowing economic growth. Resolution of these challenges will likely require both a reduction in debt and a means of achieving economic growth. These objectives can conflict, so achieving both will not be easy.
     
    With respect to the latter, the way forward seems to require increased reliance upon economic growth in developing countries, many of which have more favorable demographics and less troublesome levels of debt. However, economic, political, and social structures in some of these countries differ from those in many of the developed countries, which can lead to difficult adjustments. The need for such adjustments is nothing new, and against a backdrop of true equilibrium, would probably be relatively easy to manage. However, against a backdrop of “stable disequilibrium,” and uncertainty whether economic growth could not only lead to further economic and financial market disequilibriums, but could also undermine those political and social objectives that serve as the very raison d’etre for many countries, the willingness to make such adjustments becomes a real challenge, to say the least.
     
    If we are to be successful in balancing these concerns and objectives from the broadest possible perspective, it will require constructive efforts, cooperation, and commitment from all of us. Somehow, the corruption, injustices, and even fear of the same that typically result from imbalanced concentrations of power and/or excess reliance upon a single resource will need to be minimized.
     
    The Importance of Technology as an Engine for Growth
     
    In my last two posts, I directed readers’ attention to the fact that China controls over 95% of the global production of rare earth elements, and also holds a dominant position in many of the downstream manufacturing operations further along the supply chain. I described the importance of these rare-earth based components to a great number of technological applications, and I briefly mentioned that technology is one of the most important drivers of economic growth. Recall, for example, the impact of the Industrial Revolution. The transfer of technology among countries is, therefore, vital to a more balanced level of global economic growth. But, for capitalist economies, respect for intellectual property rights ensuring that the creators of such technology will be rewarded for their efforts is equally vital. Violations of intellectual property rights and reliance upon monopolistic power to coerce transfers of such technology could lead, therefore, not to more balanced global economic growth, but to even more worrisome levels of concentrated power.
     
    Developing an understanding of, and respect for, intellectual property rights would likely be the most effective way of limiting the various means by which such rights are inappropriately accessed and transferred. In the absence of such respect, enforcing intellectual property rights should not be the responsibility of only those who own such rights. To avoid violating the principle of internal sovereignty, government officials and legal authorities within violating countries should understand the nature and significance of intellectual property rights and should take credible actions to ensure that they are properly protected. Such actions should include effective means of preventing attempts to improperly gain access to such rights, and directly penalizing those responsible for the improper transfer of such rights. However, it should also be recognized that those entrusted with the possession of such rights must also be held accountable if they don’t uphold their responsibility to protect those rights.
     
    We Still Have the Keys So Who is Willing to Drive?
     
    Having said this, the rest of us should not sit idly by waiting for “the powers that be” to settle such matters. There is also a role to be played by private sector businesses, investors, and consumers. Our role is especially important when a lack of capital investment in certain industries has allowed certain parties to acquire monopolistic powers over relatively low-cost, but critical materials that make it easier to coerce valuable technology from businesses that possess this technology but can’t apply it without access to the critical materials. Rather than advocating the pursuit of inferior, perhaps antiquated substitutes, I believe it is incumbent upon the private sector to allocate their capital and purchasing dollars in a manner that will restore healthy levels of competition and thus market equilibrium. In other words, in my last post, when I indicated that “It’s all about the people,” I was not referring only to the managers and directors of rare earth mining companies; I was also referring to me and you, in our roles as investors, consumers, and responsible members of society.
     
    Energy and Our National Security
     
    With this in mind, I am proud to say that I will join approximately 200 people this coming week in attending the TREM’11 (Technology and Rare Earth Metals For National Security and Clean Energy 2011) conference in Washington, D.C. The two-day conference to be held on March 22-23 is being sponsored by the IAGS TREM Center, a title which includes two acronyms, one for the Institute for Analysis of Global Security, and the other for the Technology and Rare Earth Metals Center.   The stated purpose for this conference is to help secure a reliable and diverse supply chain for rare earth metals and other materials that are critical to our nation’s energy needs and security. The sponsors of the conference hope to achieve this by allowing interested individuals to join executives from the minerals, defense, energy, finance, and automotive industries in interacting with key figures from the US Departments of Defense, Energy, Interior, Commerce and State in an effort to better understand the issues surrounding metals needed for energy and security, and to influence the policies that affect the way America produces, imports and uses technology metals.
     
    Recent developments regarding skyrocketing prices and restricted access to rare earth elements had already made the relevance of this conference clear to me. However, this year’s conference unfortunately has been made even more relevant by more recent developments including unrest in several countries in North Africa and the Middle East, followed by a devastating 9.0 earth quake and tsunami in Japan on March 11. As if the human suffering caused by these natural disasters was not enough, these tragic events were followed by a series of emergencies at a number of damaged nuclear energy plants. Now, on Sunday March 20, just two days before the conference, coalition forces are staging air strikes in Libya after Col. Gadhafi’s Saturday morning attack on civilians and rebel forces in Benghazi.
     
    Running on Empty
     
    It has been difficult to observe the pain and suffering brought about by these events, so first and foremost I would like to express my sympathy for all those caught up in these calamities   At the same time, I can’t help think about ways to prevent such occurrences in the future, and in doing so, what stands out is the role that energy needs have played in both instances. We seem to be perched between reliance on oil, and reliance on rare earth elements needed to deliver us from oil. Will the Middle East remain sufficiently stable long enough to enable us to reduce our dependency on oil to less dangerous levels? How severely will the nuclear accidents in Japan discourage efforts underway to launch new safer nuclear power plants using simpler, thorium-based nuclear energy technologies? I can only hope that these recent developments will serve to strengthen the resolve of this year’s TREM’11 participants to identify better, safer ways to satisfy the world’s energy needs.
     
    I will summarize the proceedings of this conference in my next post. In the meantime, I think it would be helpful to provide some background information regarding the views and objectives of certain representatives of the IAGS, and the IAGS TREM Center.
     
    Turning Oil into Salt
     
    I will start with Gal Luft, the Executive Director of the IAGS, and Anne Korin, the co-director of the IAGS. Together, Gal Luft and Anne Korin have also authored an important book titled, “Turning Oil into Salt.” The basic premise of the book is that the threat oil dependence presents to our national and economic security is not a function of the amount of oil we consume or import. It is a function of oil’s status as a strategic commodity. Oil’s strategic status, in turn, stems from its virtual monopoly over fuel for transportation. While there are many sources of energy available to us to satisfy our non-transportation needs, we are almost entirely dependent upon oil for our critical transportation needs. Through a combination of flex-fuel engines and electrification of vehicles to enable them to derive power from our nation’s already established electricity grid, the strategic commodity status of oil could be reduced to merely a commodity, such as salt. Years ago, salt was a strategic commodity because it had a virtual monopoly over food preservation.   But, with the advent of canning, electricity, and refrigeration, salt lost its strategic status – even though it is still in wide use today.
     
    What Else Do We Need In Order to Arrive at our Destination?
     
    Next, let me turn your attention to Yaron Vorona, who is the Executive Director of the TREM Center at the IAGS. Yaron also founded the International Lithium Alliance, a membership organization consisting of producers and users of lithium whose purpose is to provide global leadership on all major strategic issues affecting the lithium industry, particularly with respect to economics, the environment, and social sustainability.  Lithium ion batteries have important implications for the development of electrified automobiles. And, from the standpoint of national and energy security, lithium is an abundant resource that is available from numerous sources throughout the world, many located in countries such as Chile with which the United States maintains friendly relations.
     
    Estamos Bien en el Refugio los 33
     
    It is no doubt for this reason that Laurence Golborne Riveros, the Chilean Minister of Mining, has been invited as one of the keynote speakers for this year’s conference. You may recall the August 5, 2010 Copiapo mining accident in which thirty-three Chilean miners were trapped 2,300 feet underground for a record 69 days – less than six months after Chile suffered a magnitude 8.8 earthquake and tsunami. Laurence Golborne Riveros remained intimately involved in that rescue mission even after the thirty-third miner was raised to the surface on October 13, 2010 to be reunited with his family and loved ones. His dedicated, sensitive management of the rescue operation earned him great admiration by the miners and their families, and great respect among the people of Chile and freedom loving people around the world. At a time when the headlines are filled with reports of many government leaders in conflict with the people that they have a responsibility to govern, it will be an honor and a pleasure to attend his presentation at this year’s TREM’11 Conference. I hope to learn how applications for lithium, including batteries for automobiles, could lead to mutually beneficial trading relationships between Chile and the United States – and possibly even a better, safer world for all of us. 
     
     
    Apr 09 7:47 PM | Link | 13 Comments
  • Investing in Rare Earth Mining Companies – It’s All About the People
    My research into rare earth elements began as part of an ongoing effort to identify potential risks that could negatively impact my clients’ portfolios. I saw China’s stranglehold on this vital resource as a significant threat. It then occurred to me that one of the best ways to mitigate this risk is to invest in companies engaged in the development of this vital resource and the downstream products that support so many important technologies. These technologies, in turn, hold the key to the economic growth that we are so desperately seeking.
     
    The first step, of course, is to select worthy investment candidates from the growing list of rare earth mining companies and companies involved in the equally important downstream industries. If we were to reacquaint ourselves with the concept of investing as a means of allocating capital, and then sought to allocate our capital as effectively as the Communist Chinese government, these investments would ideally be made by companies that are dependent upon access to raw materials derived from rare earth elements. Although the market for rare earth elements is relatively small and profits have likewise been insignificant given the artificially low prices that resulted from China’s growing influence over this industry since the early 1990’s, such investments should make sense if companies developed business models that focus on the long-term sustainability of profits from their higher margin final products, rather than the short-term profitability of each intermediate process. Unfortunately, most companies outside China have not implemented such vertical integration strategies, and are now extremely vulnerable to the risk that they will not be able to access these vital raw materials without jeopardizing their intellectual property and business franchises. But, this has created investment opportunities for individual investors who can appreciate the importance of these relationships. 
     
    Of course, individual investors should not be expected to make such investments purely for altruistic reasons. In order for the capital allocation process to be effective, it should be based upon the long-term profitability of these investments. In other words, the activities being funded should make sense after taking into consideration their true costs and benefits. It may be helpful to conceptualize this as Chinese capital allocation with American characteristics. Within this more rational framework, this article will seek to provide investors with helpful guidance on how to invest in rare earth mining companies. In particular, I will focus upon how they should be valued, and the important but often overlooked role that a company’s board and management team are likely to play in determining a company’s failure or success.
     
    What’s the value in owning rare earth mining stocks?
     
    To begin, investors should bear in mind that their objective for investing in a rare earth mining company should be to acquire an interest in the future earnings derived from the development of these natural resources, rather than simply acquiring an interest in a rare earths deposit in a static sense. Toward this end, investors must, therefore, take it upon themselves to project what these future earnings are likely to be, and to compare their valuation estimate with the value that the market is currently assigning to the rare earth mining company. As evidenced by the bursting of previous price bubbles for many types of assets, failing to do so can have adverse consequences for investors and society at large. Conversely, overlooking attractive opportunities until it is too late can also be detrimental to investors and society.
    Toward this end, for the rare earth mining stocks that I own, I have used various discount rates to calculate a range of discounted net present values of their future earnings based upon conservative estimates of the weighted average price of the rare earth oxides that they are expected to produce over the projected life of their deposits. (Current and historical prices are posted weekly on the Lynas Corporation website, among other sources.) In some cases, ongoing operating costs are mere “guesstimates.” The resulting present values should be reduced, of course, by the projected up-front costs required to achieve a state of production. My previous post includes an example of this methodology under the heading, “Before you pay the price, ask yourself what is ‘the China price’?”
    If current rare earth prices are sustainable, the results are very attractive. Otherwise, the benefit of owning rare earth mining stocks becomes more strategic in nature, based in part upon global security concerns whose value is less tangible and therefore difficult to quantify. Under those scenarios, governments and companies whose profits are dependent upon reliable access to rare earths-based raw materials would seem to be the more natural investors. However, such strategic considerations so far have gone unnoticed. In my opinion, this means that the prices that must be paid to gain access to rare earth elements outside of China are more likely to remain at elevated levels. Consequently, those willing to commit a portion of their capital toward the development of resources outside China could possibly be rewarded with high returns commensurate with the high risks being taken.
     
    For a detailed description of the principal rare earth elements deposits of the United States, this 2010 Scientific Investigations Report by the USGS may be helpful. 
    But, while evaluating certain characteristics of deposits already owned by a particular company is obviously important, investors should be aware that there are other important considerations. Unfortunately, judging by the comments shared on the message boards for investors in these companies, undue emphasis is apparently being placed only upon such characteristics. In other words, too little thought is being given to each company’s business plan and the ability of their management to execute that business plan against the backdrop of a very challenging economic and market environment. Of critical importance to investors is not only whether a company’s management will be able to succeed in the execution of its business plan, but whether management will be able to do so in a manner that will be beneficial to existing investors.
     
    How the value in rare earth mining stocks is unearthed over time
     
    As indicated in my previous post, early investors in a particular company that has just gained access to a rare earths deposit may benefit if that company or certain of its assets are acquired shortly thereafter. But, absent such an acquisition, early investors who remain committed to the successful conversion of a deposit into a productive, profitable enterprise must be prepared to endure a multi-year development process in which the cycle of a mine life goes through several stages: exploration, discovery, evaluation, development, and operation (which may ultimately be followed by closure). Although they may not always think of it in these terms, such investors stand to gain from an increase in the discounted present value of the company’s future earnings, which may result from:
     
    • A decrease in the discount rate used to value future earnings as various development milestones are achieved. (In the example included in my previous post, using a discount rate of 15%, the discounted PV of annual earnings of $1.54 billion was calculated to equal $10.236 billion. All else being equal, if a discount rate of 30% was applied at an earlier stage of development to reflect the higher levels of uncertainty that existed before certain milestones were reached, the discounted PV of those same annual earnings would equal only $5.133 billion.);
     
    • An increase in the projected resource base that can be profitably developed;
     
    • An increase in the market price for such resources;
     
    • A decrease in the cost of developing such resources; and/or
     
    • An increase in projected future earnings stemming from synergistic horizontal and/or vertical integration strategies.
     
    Lynas Corporation – The “down under” company that has risen to the lead
     
    The pattern within which these return drivers unfold is consistent with the development process that I described in my previous post. Page 15 of a February 2011 Investor Presentation by Lynas Corporation which compares the size and progress of various global rare earths projects should also put this into better perspective. From this it can be seen that the price per tonne of ore at Lynas Corporation’s relatively large Mount Weld deposit in Western Australia is quite high relative to that of the other projects listed, and that Lynas is also expected to be the first of these non-Chinese rare earth mining companies to start production. Several years ago, the discounted present value of projected earnings from such production was less than it is today since:
     
    • Uncertainty whether Lynas Corporation would successfully achieve each of the milestones listed on the x axis of the illustration warranted use of a much higher discount rate than whatever discount rate an investor would deem suitable today;
     
    • The size of the projected resource that could be profitably developed has increased as development of the resource has progressed; and
     
     
    Despite the fact that certain projected operating costs have increased recently, from a projected $7/kilogram to $10/kilogram, these costs continue to be quite low relative to Lynas’ competitors. Furthermore, Lynas has already fully secured financing for the first stage of its two-stage construction plan, and financing that is not anticipated to be significantly dilutive to existing stockholders is expected to become available soon at terms that may be more attractive than those previously anticipated.
     
    I should have known it was going to get complicated
     
    However, a number of additional factors that investors should consider when evaluating the investment merits of various rare earth mining companies are not captured by the illustration on page 15 of the Lynas Corporation February 2011 Investor Presentation referenced above. These include:
     
    • The current market capitalization for the various companies;
     
    • The projected future costs to develop the resource and the amount of cash on hand or access to non-dilutive financing available to fund such future costs;
     
    • The existence of any “trap door financing,” such as warrants or convertible preferred securities, which can sometimes catch unwary investors by surprise;
     
    • Certain characteristics about a company’s resource(s) such as their composition (light REEs vs. heavy REEs), grade, concentration, metallurgy (which can impact processing costs), the presence of other elements that may represent additional assets or liabilities – such as radioactive elements that often accompany certain types of rare earth deposits, location (which can be further broken down into political risk and geographic risk, the latter including topographical and climatic conditions that may determine what type of mining operation is required – surface mining vs. tunnel mining – as well as whether mining activity will be possible throughout the entire year), proximity to a skilled local labor pool, and access to transportation routes and important infrastructure;
     
    • Certain characteristics about the company’s processing facilities, or other downstream operations. (The higher the cost of production, the greater the fluctuations in profits, and thus share price – and investors generally frown upon higher levels of volatility.);
     
    • The terms and conditions of any marketing agreements that the company may have in place to ensure sales of the products on attractive terms;
     
    • The company’s business plan; and
     
    • Last but not least, the background and skills of the company’s board and management team.
     
    The attribution of many of these factors to a number of rare earth mining companies was summarized in an October 10, 2010 Seeking Alpha article titled “Rare Earth Elements Part 2: Companies with REE Assets.” As such, a repetition of that detailed discussion is not likely to add much value here. However, in order to evaluate and compare the merits of investing in one or more rare earth mining companies, a matrix that takes all of these factors into consideration could be helpful. That may be an undertaking worth pursuing in a future article, but for now I would simply like to focus upon what I believe to be the most important of these factors, namely the quality of a company’s management. As indicated earlier, this is rarely mentioned in message board discussions among investors, nor is it often cited in the numerous reports, articles, and studies concerning the rare earths mining industry. For example, in response to a question on one of the message boards for investors in rare earth mining stocks asking whether anyone knew anything about a company’s management team, I recall one investor expressing his supposed belief that the company’s only other asset beside the rare earths deposit was “two guys and a pickup truck!”
     
    A skilled management team to the rescue – It’s all about the people
     
    Yet, management’s ability to meaningfully act upon all of the other characteristics of a rare earths mining company is likely to be far more important than the level of knowledge that an investor may be capable of accumulating regarding a company’s resource. Even if a relatively unskilled management team was successful in acquiring a substantial project, it should not be taken for granted that they will be sufficiently talented to develop that resource in a manner that will ultimately be beneficial to that company’s investors. In fact, the quality of a company’s board and management team is likely to be the most significant determinant of whether a company fails or succeeds.
     
    The four most important skills to be possessed by those who manage and direct a rare earths mining company are:
     
    1. the ability to raise capital. (Mining is a capital intensive business, so if a company can’t access capital, it can’t advance its projects much less its share price.);
     
    1. the ability to identify and acquire attractive projects;
     
    1. the ability to guide the project through the various stages identified on page 15 of the February 2011 Lynas Investor Presentation referenced above. (Rare earth mining companies are somewhat unique in that the process required to separate the ore into individual rare earth oxides after it has been beneficiated, crushed, and concentrated, is extremely complex and can be subject to extreme environmental scrutiny and regulations. Moreover, the separated oxides require further processing before they can be useful in the numerous technological applications for which they are so critical.); and
     
    1. the ability to make the investment community aware of management’s successful development of the company in order to boost its share price to a level that is consistent with the increased value of the company that results from their efforts.
     
    This is a balancing act. In their effort to acquire sufficient capital to advance their projects, management must avoid issuing too many shares at low prices, while still providing an attractive level of remaining upside potential for investors.
     
    So, how should investors go about evaluating whether a management team possesses these skills? The best indicator is management’s prior success – not necessarily for themselves, but for investors. And, their prior management expertise must be relevant. Individuals who have attained success in a particular field are often capable of attracting capital and exceptional staff members, and this may also enable them to gain access to an attractive project. But, without relevant expertise, they may prove to be unable to capitalize upon these competitive strengths within a new and unfamiliar environment.
     
    Apr 07 8:49 AM | Link | 5 Comments
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