Rare Earths Just Beginning to Heat Up

September 6, 2010

Our rare earth stocks have been heating up over the past two weeks as it has become increasingly clear to investors that there is a real long-term supply issue materializing, forming a catalyst for a major bull market. Many of these stocks are up a few hundred percent, however it is still our opinion that many in the industry continue to see their shares undervalued in relation to the true potential value of their projects.

We have been in this business for years and followed many sectors as they move from relative obscurity into the mainstream. Whether it be uranium or potash of recent history or gold and silver form many years past, the pattern is the same. It is our opinion that we are still in the early years of the rare earth bull market. Looking forward investors probably have three more years of a rising tide lifting all boats, so to speak. After that investors will then be required to value the companies based upon their production and technology, really the keys in this business.

Rare Element Resources (AMEX: REE; TSX Venture: RES) has been on a tear, setting new highs and ripping through C$5/share on Friday. Our viewpoint is that although we have had a great run, shares should be held and one should accumulate on any pullbacks. It is our opinion that we are still so early in the bull market that what today appear to be major moves up or down will be mere bumps in the road on the way to the summit. Rare Element’s potential remains bright as they will be reporting on the economics of their Bear Lodge project regarding the REEs potential, however there is a gold kicker here which could potentially add another, and this is a conservative estimate, C$200 million to the market cap in the years ahead should they be able to prove up a decent sized gold resource.

For investors just moving into the sector, for which there are many, they should focus on those moving projects forward. It is our opinion that at this moment Quest Rare Metals (TSX Venture: QRM) is the most attractive way to play the rare earths. The company’s Strange Lake project is blessed with the heavy REEs (HREE) and the project is open in all directions, including at depth. As we have written before, this company and their projects reminds us of Extract Minerals and their Rossing South project (although uranium, we see this as a decent example of what could happen to Quest, in short Strange Lake is a company maker, and a BIG company maker at that!). Currently the company is drilling to further establish their resource and should be releasing a Preliminary Economic Assessment (PEA) on the Strange Lake property some time soon. Months ago we stated we could easily envision Quest sporting a billion dollar market cap, as we survey the industry, we see the probability of this event increasing.

Since its busted IPO, Molycorp (NYSE: MCP) has been performing extremely well, reaching a new closing high of US$19.50 on Friday. Their Mountain Pass mine will be the first mine in full production in North America starting in 2012, thus becoming North America’s first piece in the puzzle to building an integrated rare earths industry (mining, refining and marketing). Molycorp was added to our recommendation list after the busted IPO due to the production timeline, their outstanding technology and JV with NeoMaterials (TSX: NEM) (which we think could possibly lead to bigger things), and their unparalleled knowledge of the REE deposits of North America (many of which they did work on). We believe this company could easily become a consolidator in the industry, and at today’s prices almost anything they bought would be a bargain.

It is becoming apparent to America’s lawmakers that China blindsided them, and being unprepared as they were, much like the Japanese and Europeans, have cried foul. Some recent articles (check the rare earths news section- updated daily, and a useful tool- to find them http://theinvestar.com/rare) have American leaders claiming they will complain to the World Trade Organization (WTO) about China’s quotas reducing their exports of these essential materials. This is nonsense, can anyone remember a country having the WTO penalize them because they refused to sell a product? It is usually for anti-dumping procedures! It is apparent that China for many years gave away all the rare earths and then some that the western world could consume (really an oversupplied market where the consumers took these materials for next to nothing), now they have imposed ‘anti-taking’ policies to ensure that they have the resources available to continue their massive economic build-out. The WTO will not tell China that they must continue mining all out for rare earths and exporting at their past levels while destroying their environment. This is akin to China asking the WTO to force the U.S. to reopen the Gulf of Mexico for drilling along with the coasts off of Florida and California (which have been closed for decades due to environmental concerns), after all that does drive up oil prices!

Due to this increasing awareness among America’s leaders, we feel that they will need to lock up strategic reserves of these REEs, the lights and the heavies. Molycorp and Rare Element Resources, along with a few private companies, have the LREEs taken care of in the U.S., however we believe the U.S. government is going to have to make a move of some sort regarding Ucore Rare Metals’ Bokan Mountain project in Alaska. Currently the project has both uranium and rare earth potential (with historic resources that have been drill tested), with a heavy skew towards the HREEs, however it is extremely too early to judge the economic merits of this project at this time. The company is drilling on the property once again and it is our belief from the research we have done that most of these holes will be drilled in areas where they should return significant TREO values, we just are not sure about the potential intercept widths. The company has indicated that it has a few options regarding this project, and our guess is that the company will mine the ore and then ship it elsewhere to be separated into marketable materials. This would not deliver them the highest achievable levels of revenue for the valuable HREEs, yet they could begin production years sooner and at pennies on the dollar of the total cost to do a full scale rare earth mining project. At current prices we still think Ucore offers and attractive risk-reward ratio.

China recently told Japan, and effectively the world, that they are cutting their REE exports and the rest of the world needs to find their own supplies. Now that the world knows China’s stance on the matter, we expect to see the western world’s governments begin to promote these projects on the merits of national security- both militarily and economically. The U.S. seems to have taken a newfound interest in Ucore’s Bokan Mountain with a contingent recently visiting and Canada’s SIDEX (affiliated with the province of Quebec) providing financing to Quest to continue work on their massive Strange Lake project. The world is just beginning to awaken to the potential of this key industry, and early investors will reap tremendous gains over the next couple of years.