Searching for a winner in rare-earth minerals

A look at the competitive landscape of a volatile industry.

By Motley Fool Pick of the Day Jan 31, 2012 3:50PM

By Brian Stoffel

 

Last week I offered a very basic look at the field of rare-earth minerals. Today I'll cover what the competitive landscape looks like should you consider investing in the field.

 

If you'll recall from my previous article, rare-earth minerals are far from rare: They are distributed throughout the earth's surface. It's simply that deposits can be so spread out that mining them tends not to be economically viable.

 

These minerals, however, are becoming more valuable by the day, as they are used in smartphones, electric-car batteries, wind turbines, and a host of other technologies that many expect will drive our future.

 

Big kid on the block no more?
For much of the past decade, China has flooded the market with its minerals at a steep discount, driving everyone else out of business. That recently changed, though, as the country announced it would be tightening its supply to the outside world as it focuses on using the minerals in-house.

 

This created a severe shortage, and prices for these minerals skyrocketed.

 

But just as the shortage arrived, so too did a glut of other providers on the scene -- all promising to satisfy the world's rare-earth needs. Australia, Kazakhstan, Mongolia, Afghanistan, Canada, and the United States all have mines being developed for this purpose.

 

Now, these new providers couldn't immediately offer up supplies to the world. It takes time to explore new land, mine possible ores, and go through the process of separating out the minerals. Here's the current outlook for when some of these mines will come on-line:

 

Company

Expected Launch

Capacity (Metric Tons)

Lynas (Australia)

2011

22,000

Molycorp (MCP)

Q3 2012

20,000-40,000

Arafura Resources

2013

20,000

Avalon Rare Metals (AVL)

2015

10,000

Source: Fool.com.

 

There are also several start-ups, which are just in the exploration stage, and have yet to actually offer up the minerals. Rare Earth Resources (REE), for instance, has openly stated that it "has not yet determined whether its mineral property interests contain mineral reserves that are economically recoverable."

 

It is estimated that there will be roughly 50,000 metric tons of demand that China will be unable to meet in the coming year. While it looks like Lynas and Molycorp should be able to cover most of that in the near future, it's clear that there could be a significant glut in the distant future.

 

What does this mean? Either rare-earth prices will plummet, the smaller players will go out of business, or a combination of both.

 

Any winners here?
Imagine that there was only one lemonade stand on the block for 10 years. It could offer the sweet stuff up for only $0.05 per cup (China). How could anyone compete with that? But then it left... and everyone else put up their own lemonade stand in their driveway. Who wins this battle?

 

I would argue that of the investable companies, Molycorp should be the lemonade stand most likely to win business. The main reason is its ability to differentiate its offerings -- it has better, cheaper lemonade.

 

First of all, the company is adopting environmentally friendly practices that not only engender goodwill, but also lower the risks for fines and other disasters related to mining. As Richard Martin explains in a piece for Fortune: "Rather than using expensive, trucked-in chemicals to separate the rare earths from the ore, the company will use recycled saltwater, a byproduct of mining. And instead of buying expensive electricity off the grid, Molycorp is going to produce its own energy."

 

But while environmental friendliness is nice, that alone isn't enough to guarantee business. The real coup could be in Molycorp's ability to produce its ores cheaply. According to Martin, "[Molycorp] claims it will produce rare earths for $1.25 a pound. China's cost is $2.53 a pound, while some experts believe that production from Australian mines, owned by Molycorp rival Lynas, will cost a whopping $4.59."

 

If I had to choose between those three, it's pretty clear which one I'd go with.

 

Time to make a move?
In the end, I'm not going to make a CAPScall on Molycorp, though. And I suggest you fully research the situation before putting your vote, or money, behind the company as well. The commodities market can be awfully volatile. If Molycorp isn't able to come through on its low-cost structure, it would ruin the entire investment thesis.

 

And China is also a huge question mark. Should it reverse course and once again offer up its supplies, the glut would be on. In the end, I think investing in the things these minerals are used for is the way to go.

 

Fool contributor Brian Stoffel does not own shares in any of the companies mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Tags: AVLMCPREE
1Comment
Jan 31, 2012 11:12PM
avatar
The glut is on and here comes greed up the back stretch. Isn't that a song?
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