Dacha Capital: a rare commodity play

Aug. 26, 2010 2:25 AM ETIQ9 Comments
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Alan Young's Blog
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Medium-Term Horizon, Dividend Investing, CEFs

Contributor Since 2008

Retired since 2008, when I undertook a crash course (pun intended) in market dynamics. My portfolio income supports a modest life in Thailand as well as home-buying for my child in California.

Investors who are alert to up-and-coming niche opportunities have probably heard about opportunities in rare earth mining. The story, which propelled a spate of trading last year, stems from the fact that many high-tech industries depend on "rare earth" elements (Neodymium, Europium, Terbium, Dysprosium, etc.) which are produced almost exclusively in China. China is increasingly committed to keeping its resources for its domestic use, so it's easy to extrapolate the increasing value of supplies outside of China.


But the Canadian and Australian companies that mine rare earth ore are risky investments, as are all small mining companies. And the recent IPO of US rare earth miner Molycorp (MCP) has been met with bearishness on Wall Street, as it will be some years before the company can develop the capacity to actually produce refined ore. (Much of the difficulty in obtaining these metals is in separating them from each other, as well as from other materials, in the ore).


So a much safer way to gain exposure to the rising value of rare metals is to actually own the refined ore. And that is Dacha's plan. Previously a tech/biotech investment fund, they decided in 2009 to restructure the company to invest in rare metal ore, acquiring their first hard assets in the first quarter of 2010.


The managers have targeted Terbium (Tb) and Dysprosium (Dy) as the main assets to accumulate. Both are used in naval sonar systems, and in doping magnets to maintain the magnet field in high temperature environments, such as hybrid cars and military vehicles. And "hard to get" is actually what the name Dysprosium means! (This is certainly the prototype for the fictional "Unobtainium"--but no Pandorans were injured in the stockpiling of this asset). 


What I like about this stock is that, with smart management, the investment is as close to foolproof as you can find. The metals are stored securely, mostly in Singapore.  While anything is possible, the risks that could reduce the value of this asset seem remote. But the upside has already proven spectacular The Terbium Oxide stockpiled early this year cost $360/kilo, and is now quoted at $600/kilo. Further appreciation of value seems virtually inevitable. Clearly, management knows what they are doing and have already added a lot of value to the invested capital. Yet the stock is trading at less than its net asset value. 


There are, of course, some things not to like about the stock, too. If you like to judge a company by its earnings, you will be very unhappy with Dacha, because they essentially have none. (Previous earnings reports include profits from the disposal of assets from the now-discontinued investment business, but these are being closed out). Profits from trading will be rare, because the plan is to buy and hold assets (presumably until someone is desperate enough for the metal to buy out the whole company). So there is no source of operating income.


That means that the only way to get additional capital is to issue more stock. Investors will have to be alert to this likelihood: the price bubble between March and July of this year can only be explained by investors ignoring the clear warning of a capital-raising procedure.


And while there are no earnings, there are expenses: nearly $2 million last quarter for compensation of executives and consultants, and another $1 million for other operating expenses. The assets will have to grow substantially to make this cost-effective, and a long period of price stagnation could erase a lot of gains.


And then there's the problem of liquidity. On the TSX (Toronto exchange), DAC.V has been trading on the order of 100,000 shares a day, or only about $30,000 worth. US investors must use the OTC ticker DCHAF, further impeding access. And if the CAD quote translates to US $.3104 (for example), the US investor can only bid .31 or .32, a 3% spread cost (in addition to any other transaction costs).


So, this is not a stock a retail investor should try to hold a massive position in, but it's well worth considering for part of a long-term commodity strategy.


Disclosure: Long DCHAF
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