The only thing rarer than rare earths from anywhere other than China is a rare earth stock from anywhere other than China--which is why they're hot (again)

09/27/2010 12:08 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

It was something more than a threat but less than an actual embargo.

But China seems to be putting the clamps on exports of rare earth minerals to Japan.

The New York Times reported on September 23 that China had put an embargo on all exports of rare earth minerals to Japan in retaliation for Japan’s refusal to release a Chinese fishing boat captain who was detained by Japan’s coast guard after his boat collided with two Japanese coast guard ships while fishing in waters controlled by Japan but claimed by China.

Japan has now released the captain, but the two countries remain at loggerheads. China is demanding an apology and Japan is demanding compensation for damage to its patrol boats.

It’s not clear if that the embargo was real or simply a threat. Or whether or not what it was is now over. Figuring out exactly what happened (Is happening?) with rare earth exports to Japan is complicated by export quotas that China slapped on rare earth miners earlier this year. Those quotas look to be almost exhausted so exports to Japan might have been ending in any case.

But this embargo, threat of an embargo, or quota exhaustion, is a big deal for Japan. China mines about 93% of the world’s supply of rare earth minerals and controls 99% of the supply of some minerals in that group of elements. Rare earth minerals are essential to the batteries of hybrid cars, to the magnets that turn the rotation of the blades into electricity in wind turbines, and to produce the intense light of some lasers and to amplify that light as it travels through optical cables.

In other words, if you don’t have a supply of rare earth minerals, you’re pretty much out of business in key 21st century technologies.

China’s strict new quotas—down 40% from 2009 levels—should have been a wakeup call to technology economies of the United States, Europe, Korea, Taiwan, India, and other countries that China wasn’t a reliable supplier of rate earths. When the quotas were reduced, technology analysts believed that it was a way for China to force more high-technology companies to move production to China. Want a supply of rare earths so you can make windmills? Well, you can have them if you move production to China.

But you’ve got to figure that last week’s threat has moved technology CEOs and national security leaders (since rare earths are crucial in modern defense systems) from worry to DefCon4.

The problem isn’t immediate. Most companies that use rare earth minerals have stockpiles of up to 6 months. But the search for alternative sources of supply just got a bit more pressing.

Which is why the stocks of the few non-Chinese rare earth miners have soared recently.

The United States doesn’t have a rare earth industry. The best hope for a revival of U.S. production in the not too distant future is probably Molycorp (MCP), which owns a Mountain Pass, California, mine that stopped production in 2002. The company has been selling rare earth produced for stockpiles left when the mine closed while it resumes mining activity. The company went public at the very end of July.

Molycorp raised $394 million in its IPO—after cutting the offering price. The company estimates that it will spend $511 million by the time it reaches full production of 40 million pounds of finished minerals a year in 2012.

But if you’re looking for a speculative buy in a publicly traded U.S. play, this volatile stock is just about the only name on the list. Shares are up more than 5% today

Australia’s Lynas (ADR: LYSDY or OTC LYSCF) projects that it will become the largest producer of rare earths outside of China after it begins production in 2011. The company’s Mount Weld deposit is projected as one of the richest in the world. 2011 production is pegged at 104 million metric tons of rare earth oxides. (That tonnage gets reduced as the oxides are refined into finished rare earths.)

The ADRs of Lynas, which are very thinly traded (volume averages 24,000 a day), are up more than 4% today.

There’s certainly something real in the rare earth story. I’ve owned Lynas in my Jubak’s Picks portfolio in the past.

Separating the enthusiastic froth from the fundamental values, though, is hard. I think it will get easier once the current speculative fever has a chance to cool down. I'm adding both stocks in my watch list with this post

Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio.

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