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Rare Earth Metals Continue to Soar after China Reduces Export Quotas

|Includes: AVL, GWMGF, Lynas Corp. Ltd. (LYSCF)

Since January of this year, the prices of rare earth elements (NYSEMKT:REE)  have risen between 22% and 750%, the majority of which occurred after the July announcement that China is reducing their REE quotas further.

In addition, a natural appreciation in demand for the REE’s is also ongoing, as the need for technology, as well as clean and renewable energy sources, drives the market. This sharp gain in prices is naturally bringing about a lot of attention to those companies exploring for and mining the REE’s, with share prices and valuations moving ever higher. The question begins to arise; will REE’s continue along this path for the foreseeable future, and how are resource companies looking to take advantage of these buoyant market conditions?

Rare earth elements, or rare earth metals, is a term used to describe the 15 lanthanide elements or metals, all of which display similar physical and chemical properties. More recently, it is often used to describe other ‘rare’ elements from outside this group, such as lithium and tungsten. They tend to be soft, whitish metals, which oxidise when exposed in their raw form to air, and have high melting points. These elements have a massive array of uses, many of which are involved in renewable energy products, rechargeable batteries, electronic magnets and other industrial, medical and defense technologies.

There are two broad categories the elements fall under; ‘lights’, which are very common and found abundantly in mineral deposits, and ‘heavies’, which are very rare and usually found in much lower concentrations than the light metals. Both types are always found together in rare earth deposits with the balance highly tipped in favor of the lights, usually around 97-99% of the deposit. Naturally, the rarer heavy metals fetch a higher price than the lighter elements. Examples of the lighter metals include Lanthanum, used in rechargeable batteries, and Cerium, used in glass and enamel polishing, while example of the heavy elements include  europium, used for TV color phosphors, and Terbium, used in magnets and lasers.

With the exception of terbium, today's prices for all the rare earths are the highest they have been since 2001, when price data became more widely available for individual rare earth elements. In this year along, the average price increase across the group is 300%, while since the Chinese announcement in July, the largest percentage price increases have been for samarium, cerium and lanthanum (+720%, +695% and +500% respectively).

Before looking at the specific impact of the Chinese quota moves on the REEs, it is also worth noting the favorable broader global economic recovery - though many would argue this is still somewhat tentative.

Another very significant market mover for REE’s, and one which has been having an impact even before the global recession, is the ever increasing demand for green products and renewable energy sources.

Rare earth elements are used extensively across ‘green’ products, from the rechargeable batteries used in electronic vehicles, to the magnets used in the electric motors for wind turbines, tidal power platforms and hydro power generators. Demand for these products has been increasing steadily for years, as an environmentally conscious consumer base demand more and more green solutions. As demand for the products themselves increased, so too did the demand for the raw materials used in their production, and thus broadly speaking, REE’s are being increasingly supported by growth in this sector.

Currently, China produces around 95% of the world’s rare earth metals, although in recent years Canada and Australia have begun to stand out as having very significant deposits. In recent months, the Chinese government has made a number of moves aimed at limiting supply and controlling the prices of the REE’s, most significantly in July, reducing their rare earth’s export quota for 2010 by 40%, compared to its 2009 levels. Chinese newspapers reported China’s Ministry of Commerce issued 30,258 tonnes of export quotas as of end July, around 19,887 tonnes less than in 2009.

It should also be noted that this is not a new phenomenon on China’s part, with the country steadily reducing exports of rare earths for at least the past three years. in addition to the quota reduction, The Ministry of Commerce had also indicated that it would implement a range of policies putting the government in control of private and unauthorized mines that produce rare earth elements, especially from the heavy rare earth-rich South China ionic clays, by implementing stricter regulations towards improving environmental performance of its mining sector, and requiring foreign companies to move factories to China to complete production of items using REE’s.

As previously highlighted, this increasing demand (and shortage in supply) of REE’s, and the subsequent price appreciation that has seen prices sky rocket over the past few months, and has no doubt been responsible for the increased trading volumes and value gains in those companies exposed to the REE market. This has particularly been the case with companies with assets based in more politically stable environments, such as Canada and Australia, as the ongoing supply issues from China highlight the need for producers to secure a stable supply of rare earths. Whether just aiming to gain exposure to this exciting market, or looking to invest in a resource company that focuses on something other than the more standard metals, let us consider several companies.

Firstly, Avalon Rare Metals Inc (TSX: AVL), a Canadian based exploration company, with market capitalization of approximately C$213 million, who’s primary asset is the 100% owned, advanced development stage project, Nechalacho Rare Earth Element Deposit located in the Northwest Territories, Canada. This deposit is highly significant, as it has a comparatively large balance of heavy earth metals; over 22% heavy compared with the more standard, 1-2%. If we compare the average value of Avalon’s deposit to other major deposits in the REE sector, we can see exactly how this translates. With Avalon’s Nechalacho deposit comprised of around 22.5% heavy rare earth elements, the average value per kilogram of the deposit is US$22.10. If we compare this with some of their peers, Baotou’s Baiyun Obo (<1% heavies) averages US$11.40/kg, and Molycorp’s Mt Pass deposit (<1% heavies) averages US$9.90/kg.

Another company with exposure to REE’s is Great Western Minerals (TSX: GWG), also a Canadian based exploration company who have a unique mine to market strategy; pursuing a vertically integrated business model, which it believes gives it an commercial advantage. On one end of this strategic spectrum, Great Western explores for, and plans to develop rare earth deposits. The company has six rare earth exploration and development properties in North America, and has an option agreement with Rare Earth Extraction to refurbish, re-commission, and operate the Steenkampskraal underground mine in the Western Cape, South Africa. On the other end of the spectrum the company has the capability to create value added products for end users. With the recent supply jitters coming from the Chinese quota move, this model has value now more than ever.

Australia too has its fair share of companies with significant rare earth assets, including Lynas Corporation (ASX: LYC), which in a similar way to Great Western, aims to create a reliable, fully integrated source of REE supply from mine through to customers. Lynas has acted directly on the ever increasing REE supply tightening in China, moving its concentration plant from China to Mount Weld, Australia, and building an Advanced Materials Plant in Malaysia. The company’s primary asset is their Mount Weld REE Deposit, known as the ‘Central Lanthanide Deposit’, and is, Lynas suggest, “without a doubt the world’s richest Rare Earths ore body, capable of supplying up to 20% of the global market for 30 years”.

Substantial work has been carried out in estimating the resources of the project, which allowed the development of a robust 3D geological model and the generation of a NI 43-101 compliant resource model. A comprehensive evaluation of the deposit has been completed by independent specialists and resulted in a substantial upgrade in the resource to 7.7 million tonnes at 12% TREO, for 917,000 tonnes TREO. Specifically, considering a 4% rare earth oxide (REO) cut off grade, the resource shows a measured 1.2 million tonnes grading 15.6% TREO, an indicated 5 million tonnes grading 11.7% TREO, and an inferred 1.5 million tonnes grading 9.8% TREO.

Arafura Resources (ASX: ARU) is also an Australian based REE company, a emerging REE producer currently developing its Nolans rare earths phosphate-uranium project in Australia’s Northern Territory. The company’s short term objectives are focused on ensuring that the Nolans Project obtains all regulatory approvals and that all commercial agreements are finalized, enabling them to capitalize on the REE market opportunities. Arafura suggest this will include construction of a Rare Earths Chemical Complex at a site not yet confirmed, and expect first production from Nolans to come through in 2013. As of 2008, The Nolans resource (NI 43-101 compliant) is currently at 30.3 million tonnes of measured, indicated and inferred resources, containing 850,000 tonnes of REO (grading 2.8% REO), 3.9 million tonnes of phosphate pentoxide (grading 12.9% pentoxide), and 13.3 million pounds of uranium (grading 0.44lb/t uranium trioxide).

Greenland too may have a significant role to play in the future. Greenland Minerals (ASX:GGG) is advancing the multi-element Kvanefjeld Project, which hosts Rare Earth Elements, Uranium and Sodium Floride. Located at the southern tip of Greenland, the project benefits from the potential to export via deepwater access to markets in both Europe and North America.

One final company worthy of mention, and one with direct exposure to the REE market, is Dacha Capital (TSX: DAC); effectively a commodity fund purchasing physical REE’s and storing them across warehouses, such as the London Metal Exchange (LME). The company’s investment thesis utilizes an intensive screening system to identify opportunities by measuring such factors as supply side response, diversification of demand base, and demand and supply fundamentals. As the company’s mandate is to give investors the most pure source of exposure to these commodities, they do not regularly engage in significant sales.  They do however, recognize that there is value in trading a small portion of the inventory to take advantage of volatile spot markets.

With several different options of investment vehicles to take advantage, the rare earth’s market is becoming more and more accessible. This exciting but often overlooked area of the commodity market offers a lot of potential returns, not only through an ongoing increase in demand for renewable energy and green technology products, but even more so with China’s aggressive command of the REE market.

Whether through an exploration and mining company, or more directly through a REE based fund, this market is one well worth considering.


Disclosure: no position