TALK TO AN EXPERT: Clint Cox Makes The Case For Rare Earths

Mar. 22, 2010 5:34 AM ET
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Long/Short Equity

Contributor Since 2009

Clint Cox founded The Anchor House, Inc. in 1995 to focus on special investing situations. The firm has been focused on researching the rare earth sector for over four years.

What are Rare Earth Elements?
Over the last several decades, rare earth elements (REE) have gone from being an obscure scientific novelty to becoming an essential ingredient in a significant portion of today’s high-tech hardware. According to Dudley Kingsnorth of IMCOA, the current rare earth market is worth about $1.25 to $1.5 billion. In Japan it is said that, “Oil is the blood of industry, steel is the bread of industry and rare earths are the vitamins of industry.”
REEs are used in iPods, cell phones, hybrid automobiles, wind turbines, energy-saving light bulbs, MRIs, laptop computers, fiber optics, SONAR, RADAR, flat-screen TVs, glass polishing, petroleum cracking, and much more. The list of applications is constantly expanding, and for many uses there is no current substitute for the REEs. Some of the highest growth areas for REE are magnets, high-tech alloys, and phosphors.
The rare earth elements are the lanthanide series from the periodic table and include:
Light Rare Earth Elements (LREE): 
  • Lanthanum (La)
  • Cerium (Ce)
  • Praseodymium (Pr)
  • Neodymium (Nd)
  • Medium Rare Earth Elements (OTCQB:MREE):
  • Samarium (Sm)
  • Europium (Eu)
  • Gadolinium (Gd)
  • Heavy Rare Earth Elements (HREE)
  • Terbium (Tb)
  • Dysprosium (Dy)
  • Holmium (Ho)
  • Erbium (Er)
  • Thulium (Tm)
  • Ytterbium (Yb)
  • Lutetium (Lu)
Yttrium (Y) is usually included with the HREEs. Promethium (Pr) is a rare earth but is seldom included because it is created in nuclear reactions and does not occur in nature.
Note that elements such as Gallium (Ga), Germanium (Ge), Indium (In), Niobium (Nb), Tantalum (Ta), Lithium (Li), Zirconium (Zr), and Hafnium (Hf), Tungsten (W), and Rhenium (Re) may fit into the broad category of “rare metals”, but are not rare earth elements.
The REE sector’s requirement for praseodymium, neodymium, terbium, and dysprosium is currently driving the market.
Key Factors to Watch in 2010
The Economy
This may be the single greatest factor in the rare earths market.  Many believe that an economic recovery is underway, but if not, the rare earth industry may be negatively affected.  The cautious environment of 2009 brought a substantive drop in the size of the REE market, showing the direct affect that the overall economy has as a backdrop to the industry.
The flipside is also true—if there is a marked recovery in 2010, the rare earth market should benefit greatly.
Chinese Consolidation
It is critical to be aware of China’s approach to rare earths, as it is the undisputed epicenter of the rare earth market. The focus of REEs shifted from the United States to China in the mid-1990s.  Since then, China has dominated rare earth production and is now providing about 95% of the world’s REE.
The Chinese are currently making real efforts to consolidate the rare earth industry into three distinct districts within China:
  • Bayan Obo/Baotou
  • Sichuan
  • South China
Each of these districts will most likely be under the direction of one company, with the goal of making the industry more efficient economically and more controlled environmentally. If successful, the new consolidation could dramatically affect China’s ability to control the flow of rare earths and who gets priority access to them.
Although most of the talk surrounding the light rare earths elements (LREE) in China revolves around Bayan Obo and Baotou, the Jiangxi Copper Group has stated that they will be spending hundreds of millions of dollars to develop deposits in Sichuan, and it is yet unclear what impact this will have on the market.
The mining of ion adsorption clays in Southern China is also being consolidated. There are many, many small mines that have operated over the years very inefficiently—often causing damage to the environment and to the water supply. These operations can be greatly improved, and the Chinese are making substantial efforts to do this.  
During this consolidation process there may be unexpected supply shortages because of shutdowns or increased availability of product due to new efficiencies.
China Export Quotas
Chinese leadership is very cognizant of the importance of the REE industry in today’s culture of innovation, and they currently use a number of strategies to maintain control over the market. China continues to apply export quotas and raise export tariffs on rare earths, pressuring foreign companies to move manufacturing facilities to China so that they will have access to a guaranteed supply of the REEs they need. This also promotes substantial job growth within China at a time when they desperately need to create employment for hundreds of millions of workers.
There was a considerable amount of distraction, excitement and controversy surrounding Chinese rare earth quotas in the second half of 2009.  At issue was a draft proposal mentioning the possibility of restricting export of certain rare earths. This created a media sensation, with the rare earths being thrust into the spotlight and becoming front-page news. However, the Chinese soon stated that they would not be restricting exports as suggested in the policy draft.
Most likely, China will not restrict export of any REEs. In fact, the first block of quotas for 2010 has been issued for Chinese companies and they are slightly higher than they were last year. This comes as a bit of a surprise to the market, and it seems the fear of China cutting off the West may have been overblown for now. However, we are still waiting for the joint venture (foreign entities with a Chinese partner) quotas to be released. 
Any substantial change in the quotas may impact the market far beyond its usual reach as the media is more focused on the story now, and may blow it out of proportion, as happened in 2009.
The Rare Earth World Outside of China
Chinese dominance has led to a dramatic increase in rare earth exploration outside of China. The number of junior exploration companies involved in rare earth exploration has exploded over the past year to almost 200. Most of these companies have little idea of the complexity of the rare earth market—or what it takes to get a rare earth mine to production—but there are a small number of companies that are proceeding with the thought and care necessary to provide the possibility of success.
In addition to the junior exploration companies, it is important to note that rare earth end-users are also becoming directly involved—going upstream in countries such as Vietnam and Kazakhstan with the hope of finding new rare earth supply chains to decrease their reliance on China.
For all of these projects, the difficulty will be competing with China on price, and providing the elements in proportion to what the markets need. Any company that accomplishes this will find itself in a very unique situation with vast upside potential. 
April 1, 2010 Report
Congress will get its first formal look at the rare earths industry as they have ordered “a report on rare earth materials in the supply chain of the Department of Defense” due on April 1. It is unclear what the impact of this study will be, or if it will spawn possible legislation, but it certainly has the potential to be a catalyst for change—at least for the North American market. Depending on its content, and what the next step is—if any—it may have substantial repercussions.
It is also possible that they might delay the report, as they don’t have much time to properly understand the industry and assess it according to its strategic mandate.
In addition to its affect on Congressional understanding, the response of the media, if any, will be important to watch.
New Applications
There is a history of dramatic shifts in demand for particular elements within the rare earths. When color television was invented, europium (Eu) became the keystone of a new industry. When samarium-cobalt magnets were first introduced, samarium became a superstar. Since then, neodymium-iron-boron magnets have catapulted neodymium (Nd) into the spotlight. Dysprosium (Dy) is the current darling of the sector, as it is used in hybrids to allow for operation at higher temperatures.
There are thousands of scientists around the world working diligently to develop new innovations that utilize the rare earths. At any time, there can be an announcement of such an invention that can change the entire focus of the industry.
The triennial REE conference in China entitled “The 6th International Conference on Rare Earth Development and Application” will be a gathering of scientists from all over the world (but mostly China) to hear about some of the latest developments regarding rare earth applications.
In addition to new applications, the expansion of current applications may also affect the market. One example is wind turbines. As wind power increases, the demand for Nd and praseodymium (Pr) for the larger turbines may increase dramatically. 
 The Unknown
There will be unknown events in 2010 that will undoubtedly rock the rare earth market. We will watch with eyes wide open, but we will most likely be surprised like everyone else.
Risk & the Rare Earths
Pulling rare earths out of the ground is a tricky business. First, a substantive concentration of REEs has to be located—this alone is challenging, as there are no surefire ways to prospect for rare earths.  Many of the newer companies claiming to have rare earths are recycling old deposits or latching on to known occurrences with barely more than a grab sample. In addition, companies are also assaying for REEs as they target other commodities.
Keep in mind that there are very few geologists that actually study the rare earths—and fewer still that properly understand the economics involved.
Even if a company has shown that they have rare earths in the ground, they now they have to identify and characterize the host minerals and determine if they are amenable to economic processing. Metallurgical studies must be done, as each project is unique. 
This is an exceedingly tricky business, but one that is also extremely compelling and has excellent growth potential over the coming years.

Disclosure: No Position

Disclosure: No Positions

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