REE Prices - But which prices?

Analysis Report

Dear client and investor,

The prices for Rare Earth Elements Oxides (REO) have tripled y-t-d, the recent price correction included! Over the same time span those non-Chinese companies that dig the Rare Elements out of the ground and to some extend already sell it in the marketplace with great profit (or profit potential) have dropped in value, losing some 50$ as per September 26 (see chart below).

So, what could stand behind the phenomenon of such large divergence?

Here below a list of arguments often heard that we try to confront with facts and common sense. Make up your mind to judge if yes or no the recent massive sell-off in REE-related equities is justified or just another market dislocation that offers a unique buying opportunity:

Rare Earth Oxide (REO) prices are unsustainably high and will fall back to levels seen in 2009; financial markets are forward looking and discount already tougher times for the producers.

Our take: if prices for REO would drop to levels seen before China announced export quota increases back in July 2010 that would signify a reduction in price of over 90%. This is extremely unlikely as the China domestic prices stand today some 400% higher than the export prices back in July 2010.

The Chinese, dominating 95$ of the supply side, have artificially pushed up export prices as to manipulate the market

Our take: If this assumption would hold true, than China domestic prices would still trade at low levels like in 2010. The reality is, however, that domestic prices within China have y-t-d advanced even more (+400$) than export price. Such reality rather confirms our view that China is about to consolidate its domestic markets.

World economy is entering a new recessionary cycle

Our take: if so, than yes REE-stocks might drop in harmony with the general stock market. But then, again, not only the REE-equities should drop like it is the case right now – all the REO-prices should also be under strong selling pressure. This is not the case considering that during last week China’s domestic prices increased while non-domestic prices declined ….

Due to high REE prices substitutes will replace them in a foreseeable future. In other words, their industrial importance will erode quickly

Our take: REEs are the substitute for other materials; their unique property allows significant improvements in efficiency. Industry cannot adjust that quickly in order to replace REEs but that’s a process that needs many years of R&D.

USA and EU seriously considers stock piling for REE’s. Probably not because they expect their industries to replace REEs by other materials in the near future!

REE will be in oversupply in a foreseeable future, say from 2015 onwards

Our take: to start with, it should be differentiated between Light (LREE) and Heavy (HREE) Rare Earth Elements. The first non-Chinese producers (like Molycorp and Lynas) will mainly try to fill the gap of LREE. But what’s about the HREE material that even the Chinese are lacking .. ? We clearly tend to ponder the future HREE producers as we expect the HREE to remain in supply shortage for several years to come.

Last week there was a press release telling that Japan seeks a Joint Venture with Myanmar to jointly develop rare earth metals. Given that a mine project takes about 10 year to develop, do Japanese hunt for new REE resource because of oversupply from 2015 onwards?

REE as a theme is a hype and now the market corrects

Our take: We defined 4 categories where REE-products are used most – Green Energy, Mobility, High-Tech and Agriculture. If the world, with its growing population and consumption and resulting need for more efficiency in all respects, does not fall apart tomorrow than these sectors should enjoy faster growth and higher profit margins than the overall equity market.

We certainly could extend the above list of arguments but rather invite you to listen to an interview given recently by Molycorp’s CEO, Mark Smith: http://www.cnbc.com/id/44600433 in order to get a feel of how the producer side thinks about the current situation.

Here our interpretation why REE-stocks have sold off so strongly in August-September:

China and India continued to follow a tight monetary policy given their domestic inflation rates. Soon we shall see the effect of this policy with the consequence of a cyclical slowdown in economic activity. As soon as that shall become visible to “Beijing” and “Delhi”, their respective Central Banks will loosen credit again what in turn will stimulate their GDP; extremely likely that their stock markets will turn up again and REE-related investments to follow suit.

• Market structure is another possible reason for the large underperformance. Many investors suffered losses from investments during the summer months; as it is often the case towards the end of a market correction; people sell their investments where they still have profits left. REE-related holdings might just have been liquidated to stuff holes in other areas.
• Finally, the market cap in the REE-mining sector is still limited. Entering and exiting these markets brings above average volatility. Examples are the rally from July-December 2010 and the sharp downturn in August-September of this year.
• The downside volatility is further increased by abusive short selling by Hedge Funds and possibly High-Frequency-Trading systems in certain stocks like Molycorp (12.35$ of outstanding shares).

After having reflected thoughtfully we come to the conclusion that no fundamental change happened over the last couple of months. The bullish case for REE-related investments is valid as ever. Green Energy, Mobility, High-Tech and Agriculture are themes that will stay with us for the next 10 years or longer. Great profits will be generated in these fast-growing areas with above-average equity returns as a logic consequence.

If you are not of the opinion that the modern world ends tomorrow and you’ve got a strategic allocations to stocks, then REE-equities should probably be part of your or your client’s portfolio.

Our Rare Earth Elements Fund (CHF), thus far, has performed better than a diversified equity portfolio (MSCI-world) or peer products over the last 12 months.

Our Mine-to-Market approach combined with our Geologist’s buy-side research are two key arguments for future success.

Urs Gmür, CFA
c/o DOLEFIN SA
Investment Management & Technical Research for Professional & Institutional Clients
Entity supervised by Swiss Financial Market Supervisory Authority FINMA
310, route de St-Cergue
CH-1260 Nyon
Tel +41 (0)22 99’404’88
Fax +41 (0)22 99’404’89

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