Does the rare earths mania have further to go?
By
Dominic Frisby Nov 18, 2010
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They're called 'rare', but they're abundant; they've made their investors millions; they're touted as a possible cure for greenhouse gas emissions.
Eighteen months ago barely anyone had even heard of them, but they've recently sparked a trade war between China and Japan.
In short, rare earth minerals have been one the big stories of 2010 so far.
And a high-profile initial public offering (IPO) took place yesterday in Canada of a new rare earth miner in Africa, Frontier Rare Earths.
So I wanted to take a look at these eccentric, troublesome minerals in today's Money Morning.
The growth of rare earths
The rare earths are a group of 17 metallic elements. Despite the name, they are actually quite abundant in the earth's crust. The problem is finding them in sufficient concentration to warrant their mining.
These 17 elements – scandium, yttrium and the 15 lanthanides – are used in automotive catalytic converters, hybrid vehicles and energy-efficient fluorescent light bulbs. They are also increasingly used in weaponry and in digital technology, from broadband to TV and cameras.
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China currently supplies an astonishing and alarming 95% of the global rare earths market. Indeed more than 70% of the supply of light rare earths comes from a single mine in China.
Look at the chart below of Lynas Corp, which is developing one of the world's richest rare earth deposits, in Western Australia. It clearly demonstrates the meteoric rise of the sector.
It began in spring 2009. Veteran US newsletter writer Jim Dines – one of the biggest champions of uranium several years before – recommended the rare earths. With the added impetus of a rising stock market, the gains were tremendous. For those who went long and stayed long, it has been a ten-bagger. There are many other companies with similar charts.
Whether it's tech stocks, US property, soft commodities or junk bonds, we are living in the era of bubbles: of speculative booms and busts. Some of the biggest gains, however, can be made in bubbles blown in lesser-known markets.
The platinum group metal rhodium, for example, which many people haven't even heard of, went from about $500 an ounce to $10,000 from 2004 and 2008. In the five years to 2007, uranium's price increased by similar multiples.
But, for a 'really good bubble', as with all the above booms and busts, the underlying story – the sales pitch, if you like – has to be utterly convincing. And it is with rare earths.
China dominates world supply. It's cutting exports. The metals are hard to find in worthwhile concentrations. It takes many years and millions of dollars to find a mine, develop it and bring it into production.
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There is the added issue of radioactivity – rare earths are often found alongside uranium. Meanwhile, even as China reduces the supply, demand is rising as more and more uses are found for the metals.
The rare earth boom is not over
There's no doubt that the easy money in rare earths has been made. The low-hanging fruit has been plucked. But that doesn't mean the boom is over. A lot will depend on general investor sentiment and the conditions of global stock markets. But I see many similarities between this rare earth boom and the uranium boom which ended in 2007.
They are both politically sensitive minerals. They are both extremely abundant in the earth's crust, but not in mineable concentrations. They were both tiny, niche markets that the world had forgotten, but are now suddenly essential. Many mines that once produced them have slipped into disuse. And suddenly many rare earth explorers are starting to appear, just as they did with uranium in 2006-7. The charts of the leading rare earth companies are mapping a similar pattern to those of the uranium sector. The major newsletter writers who were on the uranium train are now all aboard rare earths. And so on.
Here is a chart of Canada-listed Laramide, which is developing a quality uranium project in Australia. In terms of the size of the company, the deposit and the management involved, Laramide is very much to uranium what Lynas is to rare earths. If you look at this ten-year chart, you can see how insane the uranium boom became. From around C$0.15 in 2005 to C$16.00 by 2007 – your '100-bagger'. Laramide is one of the better uranium juniors, but it was not alone in its stratospheric ascent.
So it's possible that the rare earths story still has further to go. No guarantees, of course, but it has all the qualities needed, from underlying story to tight supply, for this mania to continue.
Watch this explorer
The latest explorer to list, Frontier Rare Earths (TSX: FRO), went public yesterday. I understand that the IPO was three times oversubscribed – which says a lot about the recent frenzy in rare earths. The company has just raised C$60m at C$3.40 a share. That's about 20% of the overall shares in issue. This gives the company a market cap of around C$300m. That's pretty big for a company at this stage.
Its stated aim is "to become one of the leading producers of rare earths outside of China and one of the first new producers of rare earths after Lynas Corporation and Molycorp". Production is targeted for 2012.
Its main project is the Zandkopsdrift in South Africa's Northern Cape Province. In the words of Frontier, this is "believed to be one of the largest known rare earth resources outside of China classified under international resource reporting standards."
The president is James Kenny, who is also director of his brother Philip Kenny's company Firestone Diamonds (LSE: FDI). Philip is a director of Frontier. Firestone was a success in the pre-credit crunch days, reaching a high of more than £2 a share. But since then, even though progress may have been made on the ground, the stock is trading at around 25p. That's almost 90% off its previous high.
If you believe in the rare earths story, Frontier Rare Earths warrants some study. There is considerable excitement about the Zandkopsdrift project and it is now well funded. Looking at recent share price activity in Lynas, in the short term, rare earths may have lost a little of their lustre. And the broader markets look shaky to say the least, so prudence is advised. So far the stock has traded at roughly IPO levels. But I own some shares, and I'll be watching the early days' trading with considerable interest.
• For more on the rare earth metals story, read the cover story from the 15 October edition of MoneyWeek magazine: Profit from rare earth 'dragon' metals
Our recommended article for today
Spending cuts alone won't solve Britain's debt problems. We need more jobs. That means encouraging the entrepreneurs who create them. Here, Simon Caufield proposes four measures to get Britain back to work.
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