A Rare Opportunity in Mining Stocks

09/11/2009 1:31 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Alternative energy and other new technologies are driving demand for rare earth elements, but China's near monopoly on supplies is jacking up prices for Western mining companies.

Lanthanum. Neodymium. Dysprosium. Terbium.

The names don't exactly roll off the tongue, but these are four of the 17 rare earth elements. You can't build a Prius, an accurate missile, or a wind turbine without them.

And thanks to the threat of an export boycott by China, which controls about 95% of the current global supply of rare earth elements, the stocks of the few non-Chinese companies with rare earth mines under construction are some of the hottest stocks on the world's most speculative stock markets:

  • Great Western Minerals Group (OTC: GWMGF), a company developing four rare earth projects, is up 948%, to 33 cents a share, in 2009.
  • That's a sluggish performance compared with Ucore Uranium (OTC: UURAF), which is developing a rare earth mine in southeastern Alaska. Shares of Ucore are up 4,181% in 2009, to 83 cents per share.

My advice, at this point, is to stand back and let the rockets cool. The speculators will move on to some other sector fairly soon. Use the time to separate the mining stories from the real mining companies.

Because behind all this speculative smoke, there is a story of global demand that's real enough to make a few of these companies very profitable long-term investments.

Here's the story in a nutshell:

In my September 9 column, "Plug Into Electric Car Batteries," I explained how the growing need for batteries used in hybrid and electric cars would cause demand for lithium, the key ingredient in the next generation of batteries, to surge from a projected 11,000 metric tons in 2012 to almost 90,000 metric tons in 2020.

Well, the same need to develop less-polluting, more energy-efficient cars is driving demand for the rare earth elements. And so is the growing market for wind turbines. And the ever-present market for military guidance and control systems.

A Little Doesn't Go a Long Way

Adding a bit of one of the 17 rare earth elements to a magnet in the engine of an electric or hybrid car increases the power and efficiency of the engine, because rare earth magnets are the strongest type of permanent magnets now made. Rare earths—numbers 57 to 71 on the periodic table of elements—improve the color in TV screens and in lasers. You'll also find rare earth elements in tunable microwave resonators, and terbium, number 65, is a key ingredient in low-energy light bulbs.

And we're not talking about trace amounts of these elements either. The electric motor in a Toyota Prius uses about two pounds of neodymium in its permanent magnets. Each Prius battery also uses 20 to 30 pounds of another rare earth element, lanthanum.

Because the magnets in wind turbines are so huge—you need big magnets to maximize the amount of electricity generated from each revolution of the relatively slow-moving blades-these generators need large amounts of rare earth elements. It takes about a ton of neodymium for every megawatt of generating capacity from wind turbines.

Fortunately, despite their name, rare earth elements aren't especially rare. They're found in relatively high concentrations in the earth's crust. One, cerium, is the 25th most-abundant element in the crust.

Global production came to about 140,000 metric tons of refined rare earths in 2008.

Compare that with projected lithium production of 11,000 metric tons by 2012.

But supplies of the rare earths that can be profitably mined aren't distributed evenly across the globe. Partly, that's the luck of the geologic draw. But mostly, it's a function of the huge environmental costs of mining these rare earths. The traditional method has been to bore holes into promising rock formations, pump acid down the holes to dissolve some of the rare earths and then pump the slurry into holding ponds for extraction of the rare earths. That extraction leaves behind a lake of water mixed with acid and various sundry-dissolved minerals. |pagebreak|

Mom and Pop Mining

It's much, much cheaper if a company can get away with spending just about nothing on controlling and treating the resulting sludge. The world's low-cost producers of rare earth elements are not huge and efficient open-pit mines, but small, completely unregulated mom and pop mining companies in China.

The Chinese government is trying to force many of these companies out of business. The motive is a combination of desire to limit environmental damage in China and to exercise greater control over exports. I'd say the latter dominates.

Over the past 20 years, the accidents of geology and the realities of unequal regulation gradually led to the closure of most of the rare earth mines outside China. The world's richest proven reserve of rare earths, a mine in Mountain Pass, California, stopped production in 2002, for example.

But rising demand is starting to change that picture. Companies such as Lynas and Arafura Resources in Australia, Avalon Rare Metals, Great Western Minerals Group and Ucore Uranium in Canada, and Molycorp Minerals in the US have crept back onto the stage with plans to start mines or resume production at old mines.

It took the Chinese overplaying their hand, however, to turn that modest trend into a speculator's dream come true. The Chinese, remember, control about 95% of global production for all rare earths. They also control about 99% of the production for rare earth metals, such as dysprosium and terbium, and 95% of neodymium. Recently, China started to reduce the amount of rare earth metals that could be exported, and this year, the plan is to reduce exports further. The Chinese Ministry of Industry and Information Technology has cut authorized production targets this year by an additional 8.1%.

Companies outside China face the very real possibility not only of paying higher prices, but of not being able to buy the raw materials they need at all.

Forcing Relocation

This seems to be a key goal in China's strategy. By restricting exports, China would force high-technology companies that need these rare earths to relocate production to China, accelerating the transfer of intellectual property to Chinese companies. It's no secret that China wants to create major wind, solar, and hybrid car industries.

That's made it possible once again to raise money to start or restart a rare earth mine outside China. For example, Chevron sold Molycorp Minerals, which it had acquired when it bought Unocal, to a group of investors that included Goldman Sachs in 2008. Molycorp will need Goldman's deep pockets, since it has to drain 95 million gallons of water out of the open pit mine in Mountain Pass and then strip away tons of rock before it can begin mining in 2012. Initially, Molycorp will process 1,000 tons of ore a day—enough, the company estimates, to produce 20,000 metric tons of rare earth oxides annually.

In Australia, Lynas and Arafura were relatively close to production until the global economic crisis pulled the financial rug out from under them. A planned bond offering by Lynas failed, and Arafura raised less money than it had hoped in its initial public offering.

The Chinese stepped into the gap, buying 25% of Arafura and offering to buy 51.7% of Lynas. That second offer, which would give the Chinese majority control, has sent Australia into a frenzy, coming as it does on the heels of the detention in China of four staffers from miner Rio Tinto on charges of stealing state secrets. The Australian government has until September 17 to rule on the bid.

Elsewhere, Ucore Uranium is at work on a project in Alaska, and Great Western Minerals is working to refurbish the Steenkampskraal mine in South Africa.

Caution Advised

Be very careful when you evaluate any of these highly speculative stocks. Great Western Minerals submitted its application to update the mine's paperwork only in April, and it is still updating its feasibility study. The risk is very real that some of these projects will never get to actual production.

Why bother? Because Chinese production is projected to reach 160,000 metric tons a year by 2015 or so. That would be up from 139,000 tons in 2008. But global demand is projected to rise even faster, resulting in an annual shortfall of 40,000 tons by 2015.

The two companies that I'd be most interested in watching are Molycorp, should it ever go from a private to public company. The Mountain Pass mine is a huge proven reserve, and the group of private investors is solid.

And I'll keep an eye on Lynas Corporation (OTC: LYSCF), provided the deal with China is for something less than majority control.

View the current Jubak Picks portfolio here 

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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