Rare Earths:

Is the present hype justified? Can we pick winners?

by Michael Hampton, AKA Dr.Bubb | November 30, 2009

What a difference a year makes. There has been a dramatic transformation for the Rare Earth companies from no hope to big hopes as the Rare Earths became the latest "hot" sector to capture investors' imagination. We all know that mining investors are prone to flights of fancy, and the staying power of dreams will be tested on a long hard road from discovery to production.

Metal Events Ltd's“5th International Rare Earths Conference" held in Hong Kong last week, was a great place for a reality check on the current state of the Rare Earths sector. Despite its history, and an ability to attract the top companies in this growing industry, the conference was concerned about their numbers. A room had been booked for 70 people, but in March it seemed that the interest level was too small to attract the usual number of participants. The organizers decided to go ahead with the same size room anyway, with whatever numbers they could get. When the doors opened on November 18th for the two day conference, there were 170 delegates, a new record - and the room was groaning with people.

The changes in market capitalization of companies involved in the conference revealed the extent of the turnaround. Picking ten public companies in the audience with Rare Earth mining projects at various stages of development, the aggregate market capitalization as of mid-November was $1.59 Billion. Using the same number of shares outstanding, and the end-2008 stock prices, the market cap would have been $518 Million. That's a rise of 206% in 10 1/2 months, far above the general stock indices. One cannot help but ask, is the present hype justified?

Dudley Kingsnorth of Industrial Minerals Company of Australia Ltd put it well in his presentation. Money is available, he said, but is not infinite. "Perhaps $2 Billion will be available to the Rare Earths sector," said Kingsnorth. "If it is spread evenly over the 57 existing projects, it will be squandered." The industry will need to advance the right projects, and advance them quickly; it is to prevent a destructive price squeeze in a few years time. The crunch may arrive as early as 2014 or 2015.

Both China and the US have seized on green technologies as a way out of the present global slump. But we are unlikely to get to a brighter greener future without the special qualities of rare earth metals. They are an essential part of magnets, batteries, glass, and other components, making them smaller, lighter, and more heat resistant. An alphabet soup of obscure elements on the periodic table, with odd names like Lanthanum, Europium, and Dysprosium, the 17 rare earth elements (REE) are used in critical applications. For instance, Rare Earths permit the manufacture of small permanent magnets, capable of operating at a wide range of temperatures. Few, if any, substitutes are available. Where there are substitutes, it is commonly one REE replacing another.

Consider the applications and you get an idea of the potential for future growth in the market. Each typical disk drive has two magnets utilizing an alloy of Neodymium (Nd), a rare earth. According to Takehisa Minowa, of Shin-Etsu Chemical Co Ltd, a conference presenter, 500 million drives are sold each year. That's 1 billion magnets, for a single high tech product. Rare earths are also needed in air conditioners, wind turbine generators, and hybrid cars. The motor for the Prius hybrid car uses 1 kilogram of Nd, and the battery uses 10-15 kg's of Lanthanum (Ln), another rare earth. Multiply that by a car market which may potentially reach 5 to 6 million hybrid cars by 2018, an optimistic figure in a presentation by Olivier Touret, Rhodia Electronics, and you have a very big demand number. On top of that, new applications are being discovered every year, as technological innovation constantly requires smaller and lighter components.

Overall annual growth rates in consumption have mostly fallen in the range of 9% to 22% per annum, according to Baotou Research Institute of Rare Earths (BRIRE.) In a paper prepared by Ms. Song Honghang, Director; and presented by her colleague Wang Yan, a review of 60 years of history showed China's remarkable role in taking production from just 1,000 tons 1978, to 2,500 in 1980, and then 20,000 in 1989. After that rapid pace, and a slowdown in 1990 from the Asian Crisis, growth resumed. From 1991 to 1995, growth was again back over 20% per annum. Over the past decade, growth has been much closer to 10% annually, which is still rapid on this bigger base. Total demand for Rare Earth Oxides was near 130,000 tones in 2008. While 2009 is a clear down year, thanks mainly to a big destocking in Japan, the potential for high growth over the rest of this decade is excellent. Our green dreams cannot be realized without ongoing growth in production of these unique metals.

The political reality (which I discussed in an article last year*) is that the world is highly dependent on China for Rare Earths. Something like 90% of annual production comes from that country, and that the Chinese are using more domestically and tightening their export quotes. BRIRE's figures show that Rare Earth Oxide ("REO") exports peaked at 55,000 tons in 2005, and have been falling as quotas are tightened. (REO figures are slightly deceptive, since the oxide is about 5-10% heavier than its REE content.) Some industry sources estimate that as much as 10,000 tons of "gray" material leaves the country outside the quotas. But this is conjecture, and the Chinese government is aiming to restrain this. This nervousness over supply sources has brought about a race for new sources of production. Manufacturers in Japan, Europe, and the US all want to see diverse sources for these critical elements, as they launch new products with REE content.

Prices are down year-on-year, but a mania for the Rare Earth miners was ignited by story coming out of one of the Chinese ministries in the Spring of 2009 that China was considering a complete ban on the export of certain rare earths in their raw form, preferring export value-added products and keep growing the jobs in China. This report was later "clarified" in the summer, but it was followed by recommendations from various stock brokers and analysts that Rare Earth related mining stocks were a good way to play the emerging green energy boom, since new mines were needed to counter a possible stranglehold by the Chinese.

In fact, with a 2008 demand for 130,000 tons of REO, a resumption of 10% plus growth could add 15,000 - 20,000 tons annually to demand. That would essential require perhaps one new world class Rare Earths mine being added each year for the foreseeable future. Fortunately, there are two giants waiting in the wings, and they are both outside China.

Lynas Corp's (LYC.au) Mount Weld deposit in Western Australia is a high grade carbonatite deposit. According to the presentation from the company's Vice President, Matthew James, the project is progressing well again. The key step was raising A$450 Million to fund remaining construction costs. In late April, China Non-Ferrous Metals agreed to invest A$252 Million for a majority stake. But the terms were not approved by the Australian government. So the company turned to the equity markets, and completed a financing at A$0.45 in October. This will allow them to complete the mine and related infrastructure, and build a large processing facility in Malaysia, where they will have access to cheaper power. Mr. James expects production to commence in the first half of 2011, initially at an annual rate of 11,000 tons. Later, they will ramp up to 20-22,000 tons, which would give them perhaps 14% of the global market in REO.

The second major project in the pipeline is a mine reopening for Molycorp Minerals. Eight private equity investors backed the company, including Goldman Sachs, Traxis Partners, and Resource Capital amongst others, allowing Molycorp to buy the large Mountain Pass project in California from Chevron in September 2008. The mine was a historic producer and holds a 30 year mining permit, and a completed environment impact statement, needing only minor revisions. But prior to full reopening, a new state-of-the-art processing plant is being built at a cost of $250 million or more. The plant will permit far higher recoveries, with less waste, and 99% purity. Once in full operation in 2012, they will have 1,000 employees and production of 20,000 tons of REO per annum, which is almost fully covered by long term sales contracts. The higher efficiencies and better recoveries may allow production to be ramped up to 40,000 tons without a new mining permit.

Geoff Bedford of Neo Material Technologies (NEM.v) spoke about the "rollercoaster ride" of 2009, and how some market participants may have over-reacted to some misinformation about falling Chinese export quotas. He does not expect a full ban on any REO exports, but rather that the Chinese will accomodate changes in demand. He also spoke of his company's involvement in the Pitinga project in Brazil, where his company is assisting a mining company, Taboca, in investigating whether their existing producing tin mine will undergo some changes in its extraction and separation methods to allow production of heavy rare earths.

Several other projects are competing with each other to meet demand growth needs beyond 2012. Avalon Rare Earths has a promising project at Thor Lake which has reached about halfway "on a 5 to 10 year journey to production." The company finished a scoping study in 2007, and undertook extensive delineation drilling in 2008. They have a deposit of 64 million tonnes, with 20% Heavy Rare Earth Elements (HREE), at over a 2% grade, with a 1.6% cutoff. This appears to be commercial, but there are still tests underway to see if transport and processing methods are workable. After a capital investment of $300 - 400 million, it could be in production by 2012 - 2013.

Donald Ranta of Rare Element Resources (RES.v) has the Bear Lodge carbonatite deposit in Wyoming, which will be the subject of a scoping study in 2010.

Also at an advancing stage is Arafura's (ARU.au) Nolan’s project, which Chairman Nick Muir spoke about. They have an approximate 30 million ton deposit, right in the "center of Australia." They have a pilot plant funded by the government, and are facing a capital expenditure of perhaps A$400 million to put a mine into production. They will be replacing their CEO, who has recently resigned, and seeking possible strategic partners.

Ian Chalmers of Alkane Resources (ALK.au) described his company's Dubbo project in New South Wales, which is a Zirconium and HREE project, which was the subject of a feasibility study in 2002, and has also received a government grant to build a pilot plant, which went into operation in 2008. Prospective buyers are presently evaluating output products. The economics of starting up an enlarged mine will be improved if zirconium, niobium, and yttrium prices line up, and allow them to sign long term offtake agreements at prices which will permit construction of an expanded mine.

Brief presentations were also given by: privately-owned Frontier Minerals which has the high grade Zandkopsdrift arbonatite deposit, in the Northern Cape province of South Africa, Greenland Minerals (GGG.au) with its Kvanefjeld deposit in the country with the same name, privately-owned Mongol Gazar with a deposit in Mongolia, and Trevor Blench spoke about his company's "small but very high grade" project at Steenkampskraal in South Africa which needs a renewal of a mining license to be restarted.

Beyond these, but not presenting are dozens of companies, with Rare Earth projects. Industry expert, Dudley Kingsnorth mentioned that there were 57 Rare Earth projects on the go, but another conference delegate told me that is figure was over 120 projects, including some newly added ones, which are based upon only "a handful of grab samples."

If history is any guide, and the market stays keen, a number of the new companies will raise enough capital to progress their projects. But how can anyone, especially an investor new to this sector be expected to pick the winners, in what is becoming a crowded field at the early stage end?

The old formula: go for size and grade may not work, because the development of RE deposits is a highly complex matter. Evaluating the potential for a gold deposit with straightfoward metallurgy is relatively easy. A poly-metallic deposit which complex metallurgy is more difficult, but picking winners in the Rare Earths sector may be the most difficult games of all. That is because there are so many different elements involved each with their own supply, demand and pricing dynamics. And then there are the problems which begin as you mine the deposit. The rare earths must be extracted and separated from each other. But then there is the "dirty secret" of rare earths, virtually every deposit is radioactive with a significant concentration of thorium or uranium bound up with the Rare Earths. This makes the separation and handling of the materials even more complex and critical and is why the price tags for capital expenditures are so very high.

The other problem is the timeline. It can take 5 to 10 years to bring one of these deposits into production. Dudley Kingsnorth provided a list of 10 steps to production, showing that it is longer and more expensive than most think. Compared with other mining projects, there are some added steps, like: defining the extraction and separation process, and running a pilot plant. And because of the radioactivity, the environmental approvals can be difficult to obtain.

Kingsnorth estimates the cost of a pilot plant and preparing a banking feasibility study could be in the region of $40 to 60 Million. And that is for a project that will only have "proven" itself on a benchtest, and so there is a risk that the money may be wasted. A typical process might involve as many as 1,000 steps. And even when the pilot plant is operating well, prospective buyers will want to evaluate the output products from the plant, and see how well they can be incorporated into their own manufacturing process. Running a pilot plant can take years ("5 - 6 years" is the figure I have in my notes), until buyers are found that are willing to sign the long term offtake agreements that banks may require to provide financing for capital expenditures. With such long time frames, Kingnorth's notion that the limited capital must be allocated selectively takes on special urgency.

There is no doubt that the Rare Earths mining sector has a bright future. The usual gold rush that we saw after the nickel discovery at Voisey's Bay and the uranium price boom of 2007 may come to Rare Earths at well. But if too many early stage companies are floated, a large number of investors in these new companies are going to be disappointed.

Are you ready to pick the future winners? Do you feel lucky this year?

contact information

Michael Hampton | Hong Kong | Email | Website

The opinions of FSU contributors do not necessarily reflect those of Financial Sense.