Recently, we have seen a pullback in the price and valuation of "rare earth" companies.
As I have stated in previous articles on SA, I believe that there is a valid longer term thesis that supports current (and higher) valuations of these companies. While Japanese demand may have slipped due to the tragic events in March, this is a temporary setback. Demand will continue to increase as more countries attempt to secure RE stockpiles (especially those rare earth elements/minerals produced outside China).
One example of this is The Fiscal Year 2012 National Defense Authorization bill (H.R. 1540) that was passed by the House Armed Services Committee included a provision that will require the Defense Logistics Agency Strategic Materials (formerly the Defense National Stockpile Center) to develop a plan to establish an inventory of rare earth oxides, metals, alloys, and magnets for defense purposes. Specifically:
SEC. 835. RARE EARTH MATERIAL INVENTORY PLAN.
(a) REQUIREMENT. — Not later than 180 days after the date of the enactment of this Act, the Administrator of the Defense Logistics Agency Strategic Materials shall submit to the Secretary of Defense a plan to establish an inventory of rare earth materials necessary to ensure the long-term availability of such rare earth materials, as identified by the report required by section 843 of the Ike Skelton National Defense Authorization Act for Fiscal Year 2011 (Pulic Law 111-383; 124 Stat. 4282) and as otherwise determined to be necessary. The plan shall — (1) identify and describe the steps necessary to create an inventory of rare earth materials, including oxides, metals, alloys, and magnets, to support national defense requirements and ensure reliable sources of such materials for defense purposes; (7) identify and describe the steps necessary to develop or maintain a competitive, multi-source supply-chain to avoid reliance on a single source of supply; (8) identify and describe supply sources considered by the Administrator to be reliable, including an analysis of the capabilities of such sources to produce such materials in forms required for military applications in the next five years, as well as the security of upstream supply for these sources of material ...
What kicked off the opportunity was China tightening quotas on rare earths. Well, it's at it again. From the Australian):
China said today it would expand export quotas for rare earths to include iron alloys containing the elements, further tightening shipments of the minerals used in a variety of high-tech industries.
From tomorrow, iron alloys containing more than 10 per cent of rare earths by weight will fall under the export quota system, the commerce ministry said in a statement.
The ministry said the move would "more effectively protect the exhaustible materials and the environment."
China has previously imposed export quotas for pure rare earths only -- 17 elements critical to manufacturing everything from iPods to low-emission cars, wind turbines and missiles.
The decision to include alloys into the existing quotas is expected to close loopholes by which exporters can sidestep current regulations, thereby further reducing the amount of rare earth elements in the country's exports.
And in addition, this:
China's State Council on Thursday issued a national guideline that aims to promote sustainable and healthy development of the country's rare earth industry.
China will take effective measures to strengthen the management over the sector and speed up transforming the development pattern of the industry in order to protect and properly use rare earth resources, the guideline stated.
Special campaigns will be launched to crack down on illegal mining activities and excessive production, and greater efforts will be made to combat practices that pollute the environment and damage the ecology. The campaigns will also target illegal exports and smuggling of rare earths, the guideline said.
Specifics in Thursday's guideline also include efforts to implement greater order in rare earth exploration, smelting and extracting, and market distribution over the next one to two years.
During the period, industrial concentration will be improved as large companies will dominate in the sector, the guideline said.
Earlier this month, Ernst & Young waded into the fray:
Demand for rare-earth elements, used in hybrid cars, consumer electronics and wind turbines, could leap by 60% by 2016, Ernst & Young said on Wednesday.
Leader of the company’s mining practice in Quebec, Zahid Fazal, said that China, which accounts for over 95% of global production of the metals, will not be able to meet its own requirements from 2012 to 2015.
“We're already seeing companies crowd the market with new projects aimed to fill the estimated supply gap,” Fazal commented in a media release.
“But because these projects are risky, getting the right financing in place can be difficult, and we could see a fierce fight for cash in a limited investor pool.”
He added that there would likely be a “a race to the finish line” for company’s to get their projects into production and capitalise on the high prices.
“There is still time to develop a number of vertically integrated players in the heavy rare earth space where first mover advantage could generate real benefits,” said Ernst & Young.
"We're in a supply crunch right now, and it's a pretty severe one," says Smith. "This year the demand will be 55,000 to 60,000 tons outside of China, and everyone's best guess right now is that China will be exporting about 24,000 tons of material. We'll survive because of industry inventories and government stockpiles, but I think 2011 will be a very, very critical year in terms of supply and demand."
On CNBC, there is a number of video clips with relevant CEOs. Bottom line of the videos:
- 2015 most mines should be coming on-line.
- Growth will continue as demand increases across products.
- More companies looking for offtake (India, Russia, Korea and China).
- Funding will be needed to continue capital spending.
Impediments to thesis:
- Limited facilities: Although rare earth metal prices are surging due to favorable demand conditions, there are currently no separation facilities for the all-important "heavy" rare earths outside of China, leaving North American explorers to struggle for revenues.
- Alternatives: The rare element neodymium is the most oft-mentioned threat to the electric-drive vehicle market. It's the magnet in so-called fixed-magnet motors, which make up the majority of motors used in modern battery-powered applications, including hybrids and EVs. Induction motors are distinct from fixed-magnet motors in that they use aluminum or copper conductors to create electromagnetic fields, without magnets. This in turn allows them to be manufactured sans rare earths.
- Increase in supply: Many of the companies involved in the rare earth space have projects coming on-line in/around 2015. When this happens, the supply/demand factor changes and mineral pricing should decrease.
Goldman Sachs analyst Malcolm Southwood, however, said the price boom is nearing its peak. The supply deficit will peak at 18,734 tons this year, equivalent to 13.2% of a forecast 141,524 tons of demand, before the market slips into a slight surplus in 2013, he said in the report published Thursday. The surplus will rise to 5,860 tons or 3.2% of projected demand in the following year, the report said.
Initially, at least, prices will likely continue to rise, he said. The basket price for the Mount Weld rare earths should climb to $227 a kilogram next year, a gain of about 40%. Prices may eventually moderate to an average of $82 a kilogram, but that will happen only in 2015, the third consecutive year of a global surplus, the report said.
"We envisage a closely balanced market in 2013, and modest surpluses thereafter — at least, for some of the more abundant light rare earths — with some price softening in the 2013-2015 period," according to the report.
Bottom line: I believe that rare earth companies still represent a good intermediate- to long-term investment due to continued restrictions on supply (in the near-term) and continued increase in demand. Yes, prices will moderate when more projects come on-line, but as this looks to take place in three to five years, there is still a supply/demand imbalance which favors current/increased pricing. I would also expect some of the larger players to embark on a "roll up" strategy in order to geographically diversify and realize the benefits of increased scale.
Disclosure: I am long OTCPK:GWMGF.