Why Rare Earth Elements are Rare, Really!

January 12, 2011

 

Matthew B. Smith

 

The rare earth element equities have been the strongest movers over the past year, even the past 18 months if one were to look that far back.  We feel that we have done a good job highlighting individual equities for investors, however based on some of the questions we have received and recent market events where companies have been identified as rare earth element companies but which certainly were not, we believe that we should highlight the basics for our readers.

 

Rare earth elements are special due to their properties.  They are found in many consumer products including iPods, flat screen televisions, computers, tablet PCs, smart phones and electric hybrid vehicles as well as industrial products ranging from oil refining equipment to the high strength magnets found in wind turbines.  Also of importance are their military applications for missile guidance/propulsion systems and their applications for other military gear such as night vision goggles and their uses on aircraft.

 

Obviously these rare earth elements might be the oil of the future and much has been said about the companies scattered throughout the world in various media outlets, however they seem to be blown away by the tremendous gains.  It is our opinion that we are in the early innings of this bull market, and rather than focusing on what the rare elements are, or what these companies possess, they (once again the media) throw them all together and talk about how amazing the gains are and some editorialize about whether they think this move can continue going forward.

 

But many still do not know what rare earth elements are, as they are seldom broken out by themselves as a standalone investment.  A case in point is the Market Vectors Rare Earths/Strategic Metals ETF (REMX) by Van Eck, which is commonly, but incorrectly, referred to as an REE ETF.  Fact is it has REE exposure in the fund, however it is far from a pure-play for investors as it has significant exposure to molybdenum and other metals (thus the strategic metals reference in the name).   So what are they?  Rare earth elements (REEs) are a group of elements/metals generally defined as the 15 lanthanides and Yttrium.  One can further break down the rare earth elements into two district groups, the light lanthanides (commonly referred to in the mining industry as light rare earth elements or LREEs) and heavy lanthanides (these being referred to as heavy rare earth elements or HREEs).  Yttrium is included in the rare earth element group due to its characteristics that are similar to the heavy rare earth elements.

 

There seems to be a lot of confusion in the market place related to what constitutes a rare earth element.  So remembering that lanthanides are the scientific name for this group, here is the list of 15 lanthanides along with Yttrium so there is no confusion regarding what is or is not a REE.

 

The  Rare Earth Elements are as follows:

 

The Non-Lanthanides:

Yttrium

 

The 15 Lanthanides:

 

Light Rare Earth Elements (LREEs)

Lanthanum

Cerium

Praseodymium

Neodymium

Promethium

Samarium

 

Heavy Rare Earth Elements (HREEs)

Europium

Gadolinium

Terbium

Dysprosium

Holmium

Erbium

Thulium

Ytterbium

Lutetium

 

It is important to keep in mind that Yttrium is considered a HREE, so that would be the column we put it in if we had only broken it down between HREEs and LREEs.

 

Most people do not know what rare earths are, where they are found, what the deposits are like, or whether these REEs are rare or not.  So let us cover that as well.  Anyone telling investors that, as a group rare earth elements, as we have described above, are rare are lying.  That is the truth.  If one were to look at their parts per million (known as ppm in the industry) measurement in the earth’s crust, they would find that Cerium and Lanthanum are the most common of the bunch (60 and 30 ppm respectively) with Neodymium not far behind (28 ppm).  Although not a HREE, the rarest is Promethium, which is a bit of a trick as it is not found in the earth’s crust because it is only stable for a short while in laboratories.  According to our research we have accumulated over time, the LREEs are the most abundant of Lanthanides and the HREEs, those that are Lanthanides, are far rarer (Yttrium at 33 ppm is much more common in the crust, thus why we stated Lanthanides in the previous statement).

 

Most who either are bearish on the industry, or simply do not know what they are talking about, like to point out that Cerium, Lanthanum and Yttrium are quite common as measured against other metals with industrial uses and thus these REEs, as a whole must be overvalued and thus need to come down to a realistic price.  Here is where the REEs become really special, and one begins to appreciate the overall investing theme.

 

Although on the surface, at first glance if you will, the REEs are common, you have to first find them in a deposit.  This is where it gets really tricky for the REE exploration companies.  First, one does not go out and try to find a Terbium, Europium or Ytterbium deposit due to the fact that REEs are found in deposits together, all may not be present in economically mineable quantities or there at all, but generally they are found together also accompanied by either uranium or thorium. Most deposits can be broken down into a LREE or HREE deposit, with the HREE deposits being the more valuable ones.  Generally speaking, HREE deposits are approximately 50% HREEs and the rest LREEs (this depends on the deposit of course, but getting over 50% HREEs in an economic deposit is rare). So once one finds a deposit, the easy part is over (yes, we said easy, because from here on out it gets much harder!) because the company must figure out whether the national government will allow them to extract radioactive materials and either process them for sale or discard into a tailings pile.  Even if the national government allows the radioactive materials to be processed, it is likely the local governments from a state/province level with have further barriers along with municipalities and, in some cases, even First Nations/Native lands issues.  Many projects cannot even get past these issues to drill, let alone build a mine and produce from it!

 

Around the world there are many REE deposits, however they simply are not economic.  Even uranium mines that are currently mined today have REEs that they simply throw into the tailings, it just is not economic to try to make the REEs a by-product for the mines.  There are some in Kazakhstan, Eastern Europe and most notably BHP’s Olympic Dam, but in all cases it is a very small amount.  Even if you found a huge REE deposit, much like the ones found in Russia, that are by some estimates the largest undeveloped REE deposits in the world, there is a chance that they would still not be economical.

 

Many current companies are drilling and proving up REE deposits around the world right now, however the most important fact when it comes to mining, especially when dealing with more than one target, is the metallurgy.  We are not going to call anyone out in this article, however no matter how rich, how large, or how close to the surface your deposit is, if you cannot separate the REEs out of the ore you mine, there is no way you will have a producing mine.

 

If this were not enough to convince one of the merits of the REE industry, even if you discover that your metallurgy is good, one cannot expect to simply provide the market with a mixed concentrate of your total output.  Customers want the refined highly pure stuff, so one has to build a special plant in order to get the prices everyone quotes from China.  The best way I can explain this in a way most investors will understand is that it resembles the oil market.  Everyone looks at the NYMEX Light Sweet Crude as a benchmark, however a refinery who buys oil will not buy heavy, thick tar sands output at the same price as it requires more work.  The same thing goes for REEs, except customers needing them do not have the capability of purifying these, so really the miner needs to do it.  The processing plant and equipment is what really adds to the cost of the mine, so yet another barrier to entry here.

 

This final step is one which has caused some varying opinions here in the western world.  Some argue that the companies themselves need to step up and do just as Molycorp and Great Western Metals are doing and actually make the magnets and other materials to sell to the end user.  This is where a lot of money could be left on the table, by the miners if they do not, however with the Chinese, Japanese, South Koreans, Molycorp, Great Western Metals, Neo Materials Technologies, and others capable of making these magnets and other materials, there are ample customers with plenty of demand to make healthy profits at current prices.

 

To summarize why rare earth element DEPOSITS are rare:

 

Barriers to Entry:

 

Finding a deposit

Jurisdiction/Mining friendliness of where deposit is located

Making sure deposit is economical

Proving that the metallurgy is suitable for mining

Being able to separate your production into highly purified concentrates

Possibly having to manufacture the products from your production (if prices go down from here)

 

One must also remember that all rare earth elements are not created equal.  Investors will make more money off of HREE mines, than those focused on the LREEs.  HREE mines will also provide investors with the full spectrum of REEs and will be much better suited should an environment exist where REE pricing power disappears and their value begins to fall.  All of the current mines coming online over the next few years are mines we would consider LREE deposits.  Currently they will make money, and as they plan to be miners as well as manufacturers we expect them to be even more profitable as we have previously stated.

 

For those investors just arriving to the REE arena, we believe that this summary should guide you to make wise investment decisions.  It should also bring many of you up to speed on the industry much faster than those who have been involved with these various companies from early stages.  Using these parameters should help highlight those companies which are the real deal, and those who are merely pretenders.