In 1967, when europium was integrated into TV sets to produce
the color red, it was nothing short of a game-changer. And not
simply because we were finally able to watch TV in color -- today,
its cousins are used in a variety of applications such as
smartphones, flat-screen displays, medical imaging, GPS navigation
units, radar, night vision, missile components, DVDs, certain
high-tech batteries and a number of other devices.
It's this increasingly growing list of applications, plus the
ever-growing number of affluent users of them, that has investors
clamoring for a way to
profit
.
I'm talking, of course, about rare earth elements.
Rare earth metals comprise 17 elements. And one should note, many
of them are actually not all that rare. Gold and silver, by
contrast, are much scarcer. The trouble is, while gold and silver
are often found in large concentrations, rare earth metals seldom
are, which makes it very difficult to mine them in a cost-effective
way.
A stranglehold on supply... until now
Demand for rare earths is estimated at 135,000 tons a year. The
U.S. imports functionally all of the rare earth materials used by
industry every year. But here's the thing...
China currently controls most of the
market
.
Estimates vary, but all are above 90%, with some tallies putting
Beijing's take at 97%. However, and this is a biggie, it does not
have anywhere near that level of a stranglehold on the world's
reserves, with only about 35%.
China is a leader in the market because its government subsidizes
its production so as to encourage Western businesses to locate
factories there. It also tends to look the other way when it comes
to environmental concerns.
Mining these metals -- which are touted by green-energy champion
President Barack Obama -- is a dirty, dirty, process. Their poor
environmental record is the reason why rare earth metals have not
recently been produced in the United States.
That was not always the case. In 1949, large amounts of rare earth
metals were found in Mountain Pass, California. That mine alone was
the primary source of rare metals in the U.S. from 1965 to 1985.
The mine closed part of its operations after wastewater trouble in
1998, and operations were suspended entirely in 2003. The following
year, a German company shut down a major plant in Elizabethtown,
Kentucky, and the Japanese giant Hitachi closed a production
facility in Edmore, Michigan, in 2005.
Now, let's keep in mind that while these plants are shutting down,
demand is spiking. The iPod became a hot seller, then the iPhone,
along with a host of other devices that required rare-earth
elements. Then in 2005, China began to limit production and impose
export tariffs on rare earth materials. Not surprisingly, prices
started to rise. This begins to make policymakers nervous due to
the myriad military applications of these metals.
This led to the Department of Energy developing its first-ever
strategy concerning rare earth metals. At about the same time, HR
4866, the Restart Act, was introduced by a Colorado congressman.
The purpose of the bill was to "reestablish a competitive domestic
rare earths minerals industry..." It dies. Two years later, a
miffed President Obama takes an unfair trade case against China to
the World Trade Organization.
The resolution of that case is pending. China, which cut supplies
to Japan after a maritime boundaries dispute, has said that it must
limit production and exports so as to limit environmental damage.
Although clearly a lot of malarkey, one sort of has to admire the
chutzpah of the claim.
The outcome of the resolution is anyone's guess. In the
meantime, other facilities are coming online to mine rare earths.
The Mountain Pass mine in California has reopened, not to produce
rare earths, but to refine the stocks it has already extracted.
There are also major sources being tapped in Australia, Russia and
Mongolia.
The easiest and best way to invest in this growing
industry
There are not a lot of easily accessible investments in this space.
Rare earth metals themselves don't trade on many major exchanges,
and many of the biggest producers are global mining giants (and
don't trade on U.S. exchanges). The best way is to own
shares
of
Molycorp (NYSE:
MCP
)
, a $2.5 billion miner based in Colorado. This is the company that
operates the Mountain Pass mine.
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Management wants to restore the facility to its previous productive
grandeur, and it has already fully funded the first two phases of
its redevelopment. The first phase will bring some 19,050 metric
tons worth of production online by the end of the
calendar year
, and by mid-2013, just six months later, Phase II will be
complete. After that, the mine will be able to generate 40,000
metric tons per year -- roughly one-third of the worldwide supply.
And Molycorp can not only extract it, but also complete "
downstream
" value-adds, like refining.
The absolute low-cost producer in rare earths
The real kicker with Molycorp is its cost structure. It costs the
company $2.77 a kilogram to get the stuff out of the ground. That
is less than half the $5.58 it costs the Chinese, and it's a
fraction of the $10.11 it costs the Australian rare-earth miner
Lynas.
A recent piece in the
Financial Times
pegged the cost of rare-earths at $121,000 per ton. Think about
what that means. There are 2,204.6 pounds in a metric ton, which
puts the retail price per pound at $54.88 and the net take per
pound at $52.11 or $114,880 a metric ton. That's ballpark, but
we'll go with it.
.png)
At an output of 40,000 metric tons per year, which we can expect in
the next year, that's profit -- not revenue -- of $4.6 billion. And
that's assuming rare-earth prices do not rise. Of course, they
likely will:
Apple (Nasdaq:
AAPL
)
might be out of big ideas
, but that's not going to stop it from selling a jillion iPad 3s.
And every one of them needs rare earth elements.
That level of profit would knock the cover off the ball for
Molycorp, which had total revenue of $400 million last year. It
also made $117 million in profit, which is a notch better than
major mining outfits like
Rio Tinto (NYSE:
RIO
)
.
Risks to Consider:
The WTO case regarding China is not going to open up a flood of
cheap exports. These metals are too precious to just give away, and
the WTO isn't going to force China's hand. Clarifying the
geopolitical issues might stabilize prices, but it is not going to
crater them. But here's the beautiful thing. Even if that were the
case, it would only serve as an all-the-more compelling reason to
buy Molycorp at its current pricing and watch it profit from its
coveted position as the low-cost producer.
Action to Take -->
All in all, this is a company in the catbird seat. It has the raw
supplies, the history of industry leadership and the tacit backing
of the White House. It is also on pace to deliver a very rich
revenue stream.
I recently told my readers to add Molycorp shares at any price
under $35. This is a hot stock with a wide moat around its
profit center
that's backstopped by the wide industry trend that is mobile
devices. All in all, I like its prospects.
--Andy Obermueller
Andy Obermueller does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of RIO, MCP in one or more if its "real money"
portfolios.