Stockhouse Short Report: Is the REE bubble about to burst?

U.S. research report tells investors in rare earth element stocks to be wary. It says the world could be awash in rare earth elements if and when the Mountain Pass mine gets into production.

A U.S. research report is raising red flags in the direction of rare earth stocks, including Canadian junior Rare Element Resources Ltd. (TSX: V.RES, Stock Forum) (AMEX: REE, Stock Forum), and telling investors to be wary.

The report by “Shareholder Watchdog’’ follows a surge in the value of Rare Element Resources shares, which traded at $13.91 on Thursday. That’s up from $2 in July.

Although the Vancouver junior has zero revenue, and posted a loss of $1.7 million or 6 cents a share in the year ended June 30, 2010, (compared to a year earlier loss of $1.2 million or 5 cents), it has a market value of $447 million, based on the 32million shares outstanding.

Rare earth elements are a collection of seventeen chemical elements with tongue twisting names such as scandium, yttrium. Found in the earth’s crust, they are applied in a wide range of devices, including superconductors, and magnets.

Stocks in the sector have skyrocketed amid concerns about export restrictions in China, currently the source of 95% of the world’s production.

The recent Molycorp Inc. (NYSE: MCP, Stock Forum) IPO has also helped to put the spotlight on rare elements, highlighting the Colorado company’s plan to reopen a California mine that was shut down eight years ago

But “Shareholder Watchdog’’ says rare earth elements are much more abundant then their name implies.

It says elevated prices may be a temporary phenomenon, explaining that there are two main reasons why this will be the case:

• China will begin exporting rare earth elements again as political pressures mount.
• The report concludes that the world will be awash in rare earth supply if and when Rare Element’s Bear Lodge rare-earth elements project in Wyoming is in production in 2015.

This makes the junior a potential short opportunity, according to “Shareholder Watchdog.”

However, aside from worries about lofty commodity prices, the report sees other reasons to be wary of Rare Element Resources.

They include the commingled nature of a Vancouver office address that Rare Element shares with at least six other businesses, some of which are also managed by the junior’s senior executives.

“We believe it is a significant red flag that critical members of Rare Element’s management team are engaged with more than five companies currently,’’ the report says.

Reached in Toronto, Rare Elements chief financial officer Mark Brown dismissed the report, saying it is the price of having a stock that goes up really fast.

He said it is an insult to Rare Element Chairman and chief executive officer Donald Ranta. “This is a senior guy, now retired, who was vice-president of Echo Bay Mines,’’ Brown said. “He was also vice-president, exploration for North America with Phelps Dodge.’’

(Phelps Dodge was acquired by Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX, Stock Forum) in 2007, while Echo Bay was swallowed by Kinross Gold Corp. (TSX: T.K, Stock Forum) in 2002).

“I think there is quite a large group of people out there who are short our stock and are trying to cover because it has just gone up so fast. We had short reports of over 700,000 shares last week.”

Meanwhile, Brown took issue with the suggestion that he is spreading himself too thinly.

“We do have a bunch of companies that are all run out of the same floor as our office and they lease space from us,’’ he said.

At the top of the list is Pacific Opportunity Capital, a financial consulting and merchant banking firm that is active in venture capital markets in North America.

“Pacific Opportunity Capital is my holding company and owns 900,000 shares of Rare Element.”

Brown owns 1.5 million shares of Rare Element Resources and has a role in managing Animas Resources Ltd. (TSX: V.ANI, Stock Forum), Fox Resources Ltd. (TSX: V.FAX, Stock Forum) Avrupa Minerals Ltd. (TSX: V.AVU, Stock Forum), and Tarsis Resources Ltd. (TSX: V.TCC, Stock Forum).

“They don’t all need full time CFOs,’’ said Brown.

“It is disappointing to me that they are trashing my reputation. [The authors of the report] fail to point out all the successful companies that I have been involved with and continue to be involved with.”

In addition to being CFO at Rare Element, Brown is a director of Animas and Avrupa, President and ceo of Fox Resources, chief financial officer of Tarsis, and President of Pacific Opportunity Capital.

Still, viable rare earth element mines are a rarity in North America.

Rare Element is preparing to look at the feasibility of mining 17.5 million tonnes of 3.46% rare earths oxide, a project that Brown described as “very robust.’’

However, “Shareholder Watchdog” says the grade may ultimately prove too low to be viable under a “normalized pricing scenario.’’

“Shareholder Watchdog” is a pseudonym for unnamed writers who are interested in protecting shareholder and retail investors from potential accounting problems and business and regulatory risks.

According to a published report, “Shareholder Watchdog” has a short position in Rare Element stock, meaning that it has a vested interest in seeing the stock go down.