Is It Time You Gambled on Rare Earth Elements?

Source: Thinkstock

Source: Thinkstock

A few years ago, rare earth elements (REEs) and the shares of REE producers — particularly Molycorp (NYSE:MCP) — were on every investor’s radar. As the story went, China controlled most of the world’s supply and production of REEs, and yet these elements are essential for producing modern products from iPhones to hybrid and electric cars. In 2011, the Chinese came out and threatened to restrict REE exports to the rest of the world, and that sent prices soaring. Investors in Molycorp saw triple digit gains, and investors in some of the smaller, under-the-radar companies did even better.

But since then, investors have largely forgotten about REEs and the shares of REE producers. Molycorp, which was a darling of Wall Street at $70/share in 2011, now trades at below $3/share as REE prices are down and the company cannot turn a profit.

However, we recently got some news — reported by Bloomberg – that could turn this bear market around. The Chinese are worried about pollution, and REE mining generates a lot of pollution. The solution: restrict REE mining. If the Chinese go through with this, it follows that the global REE supply will decline and prices have to go back up again.

This means that going forward, assuming that demand for products containing REEs remains robust, REE prices will rise and that REE producers should rise in price as well. We are already seeing this as Molycorp shares are up substantially — over 10 percent — on the news.

Molycorp is an extremely interesting stock considering its incredible decline, and as a contrarian investor, I think it merits further investigation. However, investors need to consider that the bulk of Molycorp’s revenues come from two of the 17 REEs — cerium and lanthanum. The particular supply-demand fundamentals are not as strong for these two elements as they are for others. Therefore, Molycorp may be an intriguing contrarian play that can make you some money, but I suspect that the investors who look a bit under the radar are going to make the most money.

Which REEs have the best supply-demand fundamentals, and which companies produce them or will produce them? Analysts typically divide the 17 REEs into “light” REEs (LREEs) and “heavy” REEs (HREEs.) HREEs are “heavier” (i.e. they have a higher atomic number), and they generally occur in much smaller quantities than the LREEs.

A general rule of thumb is that the HREEs have superior supply-demand fundamentals with a couple of exceptions — neodymium and, to a lesser extent, praseodymium. There are several HREEs that you should pay attention to as an investor: dysprosium, europium, and terbium. These are all relatively expensive when compared with LREEs, and they also have better supply-demand fundamentals.

Which companies produce these HREEs? The answer right now is none. Other than the tiny bit produced by Molycorp and Lynas Corp. (MKTS:LYSDY.PK) — an Australian company — the vast majority of these elements come from China, which as we have seen, may cut production.

With that being the case, investors should consider non-producing companies, two of which include Tasman Metals (NYSEMKT:TAS) and Ucore Rare Metals (MKTS:UURAF.PK). Tasman Metals owns the Nora Karr project in Sweden, which has a lot of HREEs. The company released a very encouraging report last year that indicates that the mine will be economic to operate even with low REE prices. However, it will not generate any revenue for a few years, and the company needs to raise a lot of money in order to build the mine.

Ucore Rare Metals also has a project with a lot of HREEs — Bokan Mountain in Alaska. Ucore also will not be producing for a few years, and it also needs to raise capital. But Ucore recently learned that the Alaskan State Senate gave permission to the Alaska Industrial Development and Export Authority (aka AIDEA) to finance about 2/3 of the project, putting the company in an enviable position.

Ultimately, making money in REEs and HREEs in particular is not easy. The industry is very young, and it was non-existent outside of China until a few years ago. But given how essential these elements are, and given that supply from China is likely going to be restricted, this is a small industry that is worth betting on.

Since the investments mentioned here are all tiny companies that are not making profits, you need to be very careful and treat them as speculative. That means you shouldn’t put too much of your money into these stocks. But also consider that by the time these companies are generating cash-flow in 5 or 10 years a lot of the profits will have already been made.

Disclosure: Ben Kramer-Miller is long Ucore Rare Metals.

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