House Mountain Partners

Recent Strength in Rare Earths – A Head Fake or Back to the Good ‘ol Days?

Shelley Chen
  • Seemingly out of nowhere, legitimate rare earth plays exploded higher late last week 
  • Like the prices of many other commodities, rare earth prices have firmed (both inside and outside China), but a convincing move upwards is still lacking 
  • This raises two questions: Why did many of the stocks move higher last week and is this a sign of a turn or just end of year positioning to benefit from the January Effect? 

Finally Some Good News 

One of the most interesting things about the rare earth element (REE) sector is that the narrative that put REEs on investor radar in the first place is still firmly intact. However, nobody seems to care anymore. Shown below is the 1 year price performance of an equally weighted basket of REE exploration and production companies versus the Dow Jones Industrial Average, S&P 500, and Nasdaq. 

Source: Google Finance 

Source: Google Finance 

This performance can be traced to a number of issues perhaps. Challenging times face the REE exploration companies just as they do for the rest of the junior mining industry. Chinese control of almost the entire REE value chain, large capital expenditure figures for Western projects, difficult metallurgy, and higher potential returns elsewhere all seemingly have the “deck stacked” against the non-Chinese REE industry. That said, I’m still a believer in a need for a non-Chinese REE value chain and don’t believe that its importance has diminished at all, despite the poor performance in the equity markets. 

Against this backdrop, the surge last week in REE mining and exploration companies share prices was as remarkable as it was mystifying. Below is a list of REE plays and their performance on Friday ranked by volume. 

Source: Google Finance 

Source: Google Finance 

Why the Move? 

Source: The Economist

Source: The Economist

As reassuring as it was to see a broad move higher in REE plays, the move was a mystery to many, myself included. Aside from a short squeeze in Molycorp (MCP:NYSE), there was no real reason the majority of the sector here should have moved higher. Some of the recent news which should have moved the markets higher hasn’t done so. This includes renewed saber rattling between the Chinese and Japanese over the Senkaku Islands. 

If you remember, the real catalyst for the rare earth boom in 2010 was a confrontation between a Japanese warship and a Chinese fishing boat in disputed waters. Given that the current diplomatic issues surrounding the Senkaku Islands have been visible for some weeks now, it is highly unlikely that this issue alone was responsible for the recent price spike. 

Rather than one specific issue, it is likely a confluence of factors including: 

  • firming prices for REEs both inside and outside China 
  • continued encouraging economic data in the West 
  • positive news in the junior REE space including the potential merger between Tasman Metals (TSM:TSXV, TAS:NYSE-MKT) and Flinders Resources (FDR:TSXV, FLNXF:OTCBB) and excellent metallurgical results from Commerce Resources (CCE:TSXV) 
  • a short squeeze on Molycorp (MCP:NYSE), a company with almost 60 million shares in short interest as of 12/13/2013 
  • Chinese REE export quotas for 2014 essentially unchanged from the year earlier (a total of 15,110 tonnes in total for H1 2014 versus 15,499 t in H1 2013). The H1 2014 total is split between 13,314 t of light rare earth products and 1,796 t of medium and heavy rare earth products. Presumably the environmental clean-up in China continues apace. This can only help prices going forward as more Chinese production is curtailed or kept on shore to continue to build the Chinese industrial base. 

What to Watch for and What to Do Now 

Though there are still numerous companies involved in REE exploration and development, the points listed above have me convinced we are at a bottom for the REE space. It would appear that while challenging times will continue for REE plays, the “blood in the streets” phase for the sector is over. To repeat: NOTHING has changed regarding the narrative surrounding rare earths; China still dominates the value chain, putting western technological investment and defense capabilities at a disadvantage. 

For the first time in many months, consideration should be given to those REE plays that have the optimal mix of balance sheet strength, good metallurgical results, geopolitical certainty, and luck. 

The strategy and tactics for REEs and other energy metals in 2014 is strikingly similar. China is, and will remain, the 800 pound gorilla in the room. I will continue to pay close attention to what Chinese authorities do regarding confronting environmental issues, either through mine closures or export quotas. The recent outcome of the Third Plenum is an encouraging sign as China appears to be serious about restructuring its economy around consumption and less so around exports. These changes will take time, but must happen as China strives to enhance its productive capacity. Productivity increases through research and development into technology and as we saw from the 12th Five Year Plan, there is no shortage of money flowing into high-tech R&D in China. In short, watching what China does rather than what it says is key. 

What is truly happening “on the ground” in China is difficult to know, so I’ll also be paying close attention to a bevy of global industrial demand data. I’ve mentioned this in previous Morning Notes, but if the recent strength in Industrial Production and PMI and ISM data is sustained in the wake of decreasing stimulus from central banks, this will provide compelling opportunities across all types of energy metals – not just REEs. 

We cannot ignore the perilous state of the junior resource industry today, but we can take advantage of opportunities as they present themselves. I think it will still be some time before a self-sufficient non-Chinese rare earth supply chain is established, but as demand for these metals and the products they are used in continues to grow, REE investment can be a profitable choice for the risk-tolerant investor. We saw evidence of this last week. 

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