Larry MacDonald

Special to Globe and Mail Update Published on Thursday, Feb. 11, 2010 7:53AM EST Last updated on Thursday, Feb. 11, 2010 10:16AM EST

The Big Picture
The rare-earth elements – supply and demand have “a wild dynamic.”

Introduction
There are 16 rare-earth elements on the periodic table. Many of them, particularly neodymium, dysprosium, lanthanum, terbium and europium, are used to make specialized magnets, phosphors and other components in high-tech gadgets and green technologies.

Over 95 per cent of the world's supply of rare-earth elements comes from China. As its internal needs grow, China is steadily reducing the amount available for export – by 40 per cent over the past seven years, according to the Journal of Energy Security.

The thesis
Consider investing in the rare-earth niche of the resource sector.

The rationale (demand side)
Rare-earth magnets, largely made of neodymium, are used in a range of products that are growing in popularity. Examples are iPods, BlackBerrys, hard-disk drives, high-fidelity speakers and MRI machines. They are also used in clean technologies, such as wind turbines and hybrid cars (also, the batteries in hybrid cars require lanthanum).

Rare-earth magnets, sometimes doped with dysprosium, make electric motors more efficient in appliances, including washers, dryers and vacuum cleaners. For example, in the case of air conditioners, power consumption is reduced by 50 per cent.

Another major application (beside magnets) is for phosphors in computer and plasma-television screens (for example, europium is needed for the colour red). Yet another use is for making light emitting diodes (LEDs), which are about 80 per cent more efficient than incandescent lighting.

“If all of the green technologies come on stream as anticipated, demand for rare earths will scale up about tenfold over the next 10 to 20 years,” declares John Kaiser, editor of the Kaiser Bottom-Fishing Report. He adds: the rare earths have “a wild demand dynamic.” In other words, ongoing research keeps developing new applications for them.

The rationale (supply side)
China, the dominant supplier, is raising export taxes and lowering export quotas to conserve rare-earth output for domestic requirements (among other reasons). Mark Smith, chief executive officer of Denver-based Molycorp Minerals LLC, says experts predict the Chinese will be internally consuming many of their rare earths, if not all of them, by about 2014.

With trade frictions and political issues heating up in 2010, the West could perhaps be cut off sooner. “I do think the disputes could be used as a pretext to speed up the restriction of supplies,” warns Jack Lifton a Senior Fellow at the Institute for the Analysis of Global Security and publisher of the Jack Lifton Report.

End users and governments are becoming more concerned about the security of supplies. “In late 2009, legislation was passed by U.S. Congress to have the defense-supply chain analyzed by the Government Accountability Office [GAO],” observes Gareth Hatch, director of technology at Dexter Magnetic Technologies and editor of RareMetalBlog.

The GAO's report is due April 1. The report, along with the Restart bill currently before Congress, could potentially result in stockpiling and/or financial assistance to producers and refiners. Military applications of rare earths include night vision goggles, range finders, precision-guided munitions and cruise missiles.

Investing opportunities
Shrinking supply and escalating demand is a recipe for higher prices. The prospect of higher prices, in turn, is reviving interest in mines that had shut down in recent years due to lower-priced imports from China. Interest is also picking up in the development of new deposits.

Toronto-based Avalon Rare Metals Inc. (AVL-T2.470.010.41%) is the top pick of John Stephenson, portfolio manager at First Asset Investment Management Inc. They have a promising project near Great Slave Lake in the Northwest Territories; it has an extremely high concentration – over 20 per cent – in the heavy rare earths (the “heavies” are the most valuable).

One of the first companies outside of China to begin producing heavy rare earths will likely be Saskatoon-based Great Western Minerals Group Ltd. (GWG-X0.260.0051.96%) , claims Mr. Lifton. “Its South African interest is about 2 to 3 years away from production. The mine has a limited lifespan but they'll use the revenues to develop their rare-earth deposits in Canada.”

Mr. Kaiser has invested in Quest Uranium Corp. (QUC-X2.68----%) , which has a deposit near Strange Lake in northern Quebec. “It's world-class in size, reasonable grade, and has a full distribution of all the rare-earth elements, from lights to heavies,” he remarks. Moreover, it can be “open-pit mined for faster payback.”

Spotlight on Molycorp Minerals
Most rare-earth exploration and development firms are years from production and hence speculative investments. Molycorp Minerals offers a more substantive choice. It is currently privately owned but Mr. Smith, the CEO, has said his company is looking to go public when conditions are right. Mr. Kaiser has heard it could be as early as April.

Molycorp was the United States' most important rare-earth mine until it closed in 2002 (in part because of cheaper supplies from China). Private equity interests, led by Goldman Sachs and Resource Capital Funds, have since purchased Molycorp from Chevron Corp. and now have it processing tailings from previous mining activity.

Molycorp's initial public offering could raise close to $1-billion (U.S.), which “would give the rare-earth sector a boost,” claims Mr. Kaiser. As for Molycorp, the infusion will allow the company to expand operations and work on improving processes for extracting and concentrating.

As well, it may allow Mr. Smith to proceed with plans to acquire rare-earth deposits in places like Canada. Avalon or Quest Uranium could be takeover candidates for Molycorp, suggests Mr. Kaiser, because their relatively high concentrations in heavy rare-earth elements would supplement Molycorp's weighting in the light rare-earth elements.

The risks
If China's economy were to slow down, it would have less need to restrict exports. In that case, supply shortages may not materialize as soon as expected.

In addition, demand may not ramp up as fast as expected. This could happen if green technologies, such as wind turbines and hybrid cars, don't gather as much momentum as projected