Investing in Rare Earths: Restraint is Essential

By Michael Montgomery—Exclusive to Rare Earth Investing News

Investing in the rare earth market poses challenges that are not common in other commodities markets. First, there are 17 elements in the rare earth bundle that are valued individually; essentially the ‘rare earth’ market is comprised of 17 individual markets. Many of these elements are found together in deposits, the percentage of certain elements in resource estimates should be considered before investing in mining companies. Secondly, the drama of reducing export quotas from China, which accounts for over 95 per cent of world supply, has increased investment in mining companies, but also created what some fear is an unsustainable bubble in the market.

Companies like Molycorp (NYSE:MCP), and Rare Element Resources (AMEX:REE; CVE:RES) have seen share prices jump with the increased interest in this market even though many of the exploration/mining companies have yet to produce or sell any product. Investors can make a healthy profit in this market, as demand for the material will only increase in the future. However, it is on the individual investor to do their homework before simply throwing money at stock hoping for short term gains.

The export quotas have created an interesting dynamic in the Chinese supply of the elements. The dynamic stems from the details of the export policy.

“With the current quota system, China does not distinguish between the individual rare earth oxides but limits the total tonnage of exports across the board. That has led to Chinese companies exporting as much as possible of the high-value heavy rare earths like dysprosium, instead of low-value light rare earths like cerium,” reported Julie Gordon, for Reuters.

While the prices for all of the 17 elements have gone up as a result of the policy, some of the prices for lesser used elements, like cerium have gone up at a faster rate then the widely used elements such as neodymium. The result of the quota system has not affected all of the elements equally; because no one is exporting lesser used elements the supply-demand fundamentals have disproportionately affected the market. Many analysts believe that China will change the export policy to restrict the metals on an individual basis. The result of this change may be a surge of supply of the ‘light’ REE’s which there is an abundance of in China.

The demand for elements such as neodymium and dysprosium will increase due to the true increase in demand for the products that contain them, creating a more stable price structure. Long term out look for the ‘heavy’ REE’s like neodymium, are strong due to their use in electronics and magnets for electrical generation.

“Magnets mainly use the so-called middle and heavy group of rare earths, including neodymium and dysprosium. Using iron- based magnets in a mobile phone would make it much bigger, like a briefcase,” said Damien Krebs, metallurgy manager of Australia’s Greenland Minerals and Energy Ltd.

The increasing demand for products that contain REE’s will continue to rise, and the supply shortages of some of the elements over the next few years are well documented. The share price increases of some rare earth mining juniors may not be sustainable, so much so that many analysts have been describing the recent market activity as looking much like the “dot-com bubble.”

“Everybody’s standing up, waving the flag and shrieking it’s rare earths because that pushes the valuation up, a good sign that we’re in something of a bubble. There comes a point where you’ve run out of all the arguments, and at that point you’re into the Alan Greenspan ‘irrational exuberance’ range. We’ve reached that for some of these names,” stated Jon Hykawy, analyst for Byron Capital Markets.

The individual investor must put in their due diligence, and pay careful attention to the resource estimates of prospective mining companies as well as the production timeline for the mine. The urge for short term gains is powerful when looking at the share price increases for many rare earth mining companies; however many of these companies have  no product to sell in the near future. Investors should be looking for returns in the long run, as many of the mines in development will not produce for at least two years and in some cases longer than that. There is a real potential for realized gains in this market, however, it is on the investor to show restraint.