Before Casting off Those Rare Earth Stocks …

by James Brumley | February 28, 2012 9:37 am

RareEarth Before Casting off Those Rare Earth Stocks …The rare-earth merry-go-round continues to spin. For those who can get on and off, the ride is not only thrilling, but profitable. For those who can’t jump on or off at the right time, though, it’s simply maddening to see these stocks — both Chinese and non-Chinese — whipped around indiscriminately. And here’s the latest turn.

China, as a nation-state, is considering doubling its rare-earth exports this year now that demand is rising on lower rare-earth element prices.

Rare-earth metals are used to make powerful magnets used in electric cars, wind turbine generators, helicopter blades, oil refining equipment and dozens of other items we all take for granted. Ramping up China’s output of rare earths is a big deal simply because the country produces 97% of the entire world’s supply — if you’re not getting it from China, you’re not getting it.

Well, that’s not entirely the case. A few non-Chinese miners do — or soon will — supply rare earth metals.

One of them is U.S.-based Molycorp (NYSE:MCP[1]), which reopened its Mountain Pass (California) mining operation in 2011 after the price of most rare-earth elements surged in 2010 to a level where the mine could operate profitably. Canada’s Rare Element Resources Ltd. (AMEX:REE[2]) also is developing a mine, but it’s not producing yet. Australia’s Lynas Corp. (PINK:LYSCF[3]) is another major operation.

But still, China’s controls the vast majority of the supply, which means it controls the price. That doesn’t mean China always has played those cards right, though — even if in a purely self-serving way.

Find the Happy Medium Already!

If all of this seems vaguely familiar, it might be because it was only a few months ago China was cutting its export allowances, driving the price of most rare-earth metals through the roof, and subsequently killing the market — few buyers could afford the tenfold increase in rare-earth prices that materialized between 2009 and 2010. Now the pendulum is swinging in the exact opposite direction.

And, therein lies the challenge for investors: The actual demand for rare earth elements doesn’t even come close to jiving with the supply, which creates total chaos for these stocks.

The world needs about 120,000 tons of these various elements every year, though about 70,000 tons of rare earth elements are used by the Chinese for their exported products — the other 50,000 tons are needed in raw forms by non-Chinese users.

As was noted, China controls the bulk of the active supply (97%), yet dialed down 2011’s export allotment to a ridiculous 14,000 metric tons. Crimping the supply by a little could have kept prices affordable, even if painful. To simply not supply enough at all, though, then ask outrageous prices for what was made available, forces would-be buyers to “make other arrangements.” And they did — which is why rare-earth prices essentially have been cut in half since the middle of 2011.

Finally Finding a Groove

The news of China’s increased export allowances immediately hit names like Molycorp, Rare Element Resources and Lynas. Makes sense. If there’s more of it on the market, the greater supply on persistent demand means the price of rare-earth oxides sinks, and margins for the miners shrink.

This is a case where investors might want to take a step back and look at the even-bigger picture, however.

In a “normal” environment, more supply would indeed mean lower rare-earth prices. We’ve never really seen a normal rare-earth element market, though. We’ve basically seen one state-controlled supplier, and we’ve witnessed that supplier swing from flooding the market with too much of the stuff in the early 2000s (which is why Molycorp’s Mountain Pass mine closed in the first place) to unfairly limiting supply in 2010 (and pushing prices through the roof) to not putting anywhere near enough of it on the market last year, and once again destroying prices … albeit for different reasons.

Surely by now China has figured out it’s better off going with the flow instead of going against the grain.

Now What?

Though the knee-jerk reaction implies otherwise, it’s not likely that China’s new ramped-up rare-earth quotas are going to undermine the market to the point of killing non-Chinese producers. Indeed, we still need non-Chinese producers to become fully operational, if only to provide some price stability. Mostly, though, we need these miners to become fully operational because there’s a market waiting to buy their goods. And the market’s willing to pay a nice price for them.

Translation: While everyone else is selling these rare-earth mining stocks, now might be the time to do a very Buffett-like thing and take a contrarian stance — buy ‘em when nobody else wants ‘em.

China’s not looking to trip itself up again. In fact, it wants the same thing Molycorp and Canada’s Rare Element Resources Ltd. want: just enough supply to keep prices high, yet still affordable. In that light, non-Chinese miners actually win from China’s slightly higher quotas, too.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:
  1. MCP: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCP
  2. REE: http://studio-5.financialcontent.com/investplace/quote?Symbol=REE
  3. LYSCF: http://studio-5.financialcontent.com/investplace/quote?Symbol=LYSCF

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