Jacob Securities Analyst Luisa Moreno knows the rare earths sector like few others. In this exclusive interview with SmallCapPower.com, Ms. Moreno introduces you to the sector, explains what investors should focus on and discusses the sector’s large and small players.
SmallCapPower.com: What, essentially, is the investment thesis underpinning rare earth elements?
Luisa Moreno: The story behind rare earth elements (REEs) has been growing for the last five years or so. And REEs are used in most of the technologies that we use today like TV screens, smartphones, hybrid cars and computers. China produces about 97% of all those elements. During the last five years, for various reasons, China started decreasing exports and that has affected many of the developed economies like Japan, Germany and other countries that are highly dependent on these elements for their manufacturing industries. And for that reason, many REEs projects outside China have started to develop and they are important because China has decided that it does not want to continue to supply most of the world’s REEs and mining those elements is very toxic. China also wants to develop the downstream businesses that use REEs and is using lower REE prices in China to attract them.
That means that it’s in the hands of other countries to essentially produce their own REEs. But not many other countries produce REEs, with the exception of Brazil and a few nations in Asia such as India and Vietnam. That leaves the companies currently developing REEs projects to meet the demand.
SmallCapPower.com: Rare earths are 17 chemical elements on the periodic table, 15 lanthanides plus scandium and yttrium. But those elements are divided into two categories: light rare earths and heavy rare earths. Please briefly explain the differences between those two categories and the main uses for both.
Luisa Moreno: There are some magnetic and electric property differences between the light rare earth elements (LREEs) and the heavy rare earth elements (HREEs) but what is important for investors to know is that most of the deposits around the world contain high percentages of the LREEs because they are more common than the heavies. As the HREEs are less common some of them also carry higher prices. So, there is really a great deal of interest in finding deposits that carry higher percentages of the critical HREEs.
The largest application for rare earths is probably in the oil industry where a concentrate of lanthanum, the most common rare earth element and a LREEs, is used in catalysts for breaking down petroleum into gasoline and other products in a process called fluid catalytic cracking. The two most critical HREEs are dysprosium and terbium, which have high Curie points and are used in high temperature resistant super-magnets present in hybrid cars, state-of-the-art wind and tidal turbines, industrial motors, and many other applications.
SmallCapPower.com: Could you illustrate the demand picture for REEs by comparing prices for the in-demand metals – dysprosium, europium and neodymium – in October 2010 with October 2011?
Luisa Moreno: In October 2010, for instance, the price for dysprosium was about US$300 per kilogram (kg). And in October of this year the prices were about $2,300/kg. Europium was US$600/kg during the same period last year but in October of this year, it was US$4,500/kg. Meanwhile, Neodymium, which is a light rare earth element but is one of the critical elements, was trading at about US$70/kg in October last year and in October this year it was about US$265/kg. So, the prices for these elements have all increased significantly.
SmallCapPower.com: Nonetheless, those prices have come off their highs established earlier this year, so we’ve had a something of a price pullback.
Luisa Moreno: We did, but the price for some of the elements is still much higher than last year. I think dysprosium went down US$300 from the price I told you. So, instead of $2,300, I think it’s about $2,000 now.
But imagine if the price only went up to US$1,000 – it was US$300 last year. It’s really a significant jump! And that has been largely driven by fears of China decreasing exports further, but it has also been influenced by speculators – hedge funds and others – looking to profit as prices for REEs go up.
SmallCapPower.com: In a recent research report published by Jacob Securities titled Rare Earth Economic War you note that falling prices for rare earths and an unstable global economy has led you to dramatically change your forecast for several prominent companies in the sector. Please tell us more about the dynamics behind that decision.
Luisa Moreno: There was an increase in the volatility in the space in part affected by the sharp decline in rare earth demand and prices, aggravated by poor equity markets, causing share prices to fall. All the companies in the space have been affected, even Molycorp Inc. (NYSE:MCP), owner of the Mountain Pass mine in California, which is probably the most advanced rare earth mining company outside of China. Some of the rare earth companies have put out positive results and the market hasn’t reacted much because there is a lot of uncertainty. These are small-cap companies, high-beta stocks, and in this time of high volatility and lower tolerance for risk that this early stage mining companies carry, these stocks tend to underperform.
I developed a REEs price forecast, which I use in my financial models. However, the dramatic fluctuations in rare earth prices and the new developments in space related to Chinese and Japanese rare earth strategies, led me to adjust my near and long term forecasts. I have also adjusted downward the REEs recovery rates for some companies based on the quality of their metallurgical test results and my continuing learning and analysis of potential metallurgical success and costs for each company. So, I incorporated these changes in my models and updated my price targets.
SmallCapPower.com: In terms of annual sales, how large is the REEs sector and what are you projecting its rate of growth to be over the next five years or so?
Luisa Moreno: The current size of the rare earth sector is estimated at US$10-15 billion annually. Obviously, it’s difficult to estimate the actual price when prices are not stable. Global production is about 120,000-130,000 tonnes of rare-earth oxides per year. So, if you assume a weighted price of US$80,000 per tonne for all of the elements, it gets you to US$10 billion. That’s probably the size of the market right now.
But in the long term, demand forecasts indicate steady growth. In the next five years according to IMCOA, Chinese demand for REEs is expected to grow at 7-12%. Between 2014 and 2015 global REEs demand for alloy applications is expected to grow 8-12% per year. In the magnet industry demand for REE in particular neodymium and dysprosium is expected to grow by about 10% per year. So, overall we might be looking at anywhere from 5-10% growth in the sector in the next 2-5 years.
SmallCapPower.com: That’s pretty robust.
Luisa Moreno: Yes, absolutely. But those projections are connected to the potential growth of the overall global economy. Rare earths are used in all major sectors of the world’s economy, including medicine, oil, automotive, aerospace, computers, electronics and telecommunications. The performance of these sectors will have a directed impact on the demand for the various elements.
SmallCapPower.com: There was a report in the Financial Times of London that discussed the creation of a REEs stockpile in America. And the story said that the stockpile was more likely to get the green light after Baotou Steel Rare-Earth Co., which is the main producer of rare earths in China, halted production earlier this year. Such a stockpile would create a significant source of demand. Do you believe we will see a U.S. stockpile of REEs any time soon?
Luisa Moreno: It’s going to be difficult. It depends on what they want to stockpile. The U.S. could decide to stockpile different elements at the various oxide purity levels or they could stockpile REEs concentrates. If they decide to stockpile concentrate they would have to send it to a refinery and most of the refineries are in China. So building a concentrate stockpile of REEs, for instance, is probably not going to happen unless the U.S. government builds a refinery or asks future rare earths refiners in the U.S. like Molycorp to build the necessary capacity to accommodate future processing of government stockpiled REEs during potentially critical demand periods.
There are really 15 elements and each one of them is used differently at the different purity levels and sometimes in combination with each other or other elements. So, building a stockpile of individual elements would be complicated.
SmallCapPower.com: But if the U.S. builds a stockpile, aren’t other countries like Germany and Japan likely to do the same?
Luisa Moreno: Maybe, but they too have to effectively forecast what kind of elements they’re going to need. And then, because some of them are so pure, they’ll really need to find ways to isolate them and protect their purity, otherwise they might lose their quality and intrinsic value.
If the U.S. does it, others might do it, and in Europe there are discussions about that. But someone from the Rhodia Group suggested that European officials shouldn’t be focusing on that because it’s really a very complex task to stockpile rare earths.
If they insist on stockpiling I think the best way is probably to stockpile the concentrates. Then specific critical elements could be refined based on particular demand. But government officials need to have in mind that there are really not that many refineries with sufficient expertize and capacity out there.
SmallCapPower.com: Roughly how many companies are in this space and how many of those do you cover?
Luisa Moreno: There are about 300 REEs projects around the world. There are many companies on the TSX that indicate that they have rare earth deposits or assets but those actively focus on developing their rare earth projects are probable 30 or so but I am not sure. I personally cover five.
SmallCapPower.com: Less than two years ago there was basically only one brokerage covering this space. Now just about every Toronto-based brokerage covers a few companies with REEs projects. Do you believe there’s too much coverage for the size of the sector? Or does more coverage provide more positives than negatives?
Luisa Moreno: There are definitely many companies now and although there’s a number of analysts and brokers following the space, most analysts still cover the same five to eight companies. There are lots of other companies that are not covered. Many of those are at the early stages of development and perhaps need to develop further before they get the attention of institutional investors and analyst coverage. But the space is also very complex and the more analysts you have, the more information reaches the market. I think there are positives to that.
SmallCapPower.com: As you suggest, there are many challenges for companies developing REEs projects, but the two main challenges are high the costs of bringing a deposit into production and the lack of qualified people who understand the complex metallurgy of rare earth deposits. What companies, in your view, have best mitigated those challenges?
Luisa Moreno: I think companies that have deposits with types of ore minerals that have been processed before for the extraction of REEs, namely Molycorp and Rare Element Resources Ltd. (TSX:RES), are in a better position because there’s plenty of literature out there about processing the kinds of minerals in their deposits, so they should have an advantage. Molycorp has been able to raise pretty much all the money they need and Rare Element Resources is looking into building a concentration facility for less than US$150 million. That’s fairly economic compared to others.
SmallCapPower.com: What are some other names?
Luisa Moreno: Well, Matamec Explorations Inc. (TSX.V:MAT) has the Kipawa HREEs deposit in Quebec. They’re targeting a small-scale production, perhaps 5,000-8,000 tonnes REO per year. The company wants to focus on the critical heavy elements, which have a smaller market but higher prices. Matamec has received some coverage recently by my colleagues in other brokerages but it’s still somewhat under the radar. Matamec has done some very detailed work on its metallurgy; it’s fairly advanced compared to others. And we should see some type of off-take agreements there soon, potentially.
Another one is Ucore Rare Metals Inc. (TSX.V:UCU) and its Bokan-Dotson deposit in Alaska, which is similar to Matamec in terms of their deposit size and focus on heavy rare elements, particularly dysprosium.
SmallCapPower.com: As you said earlier, China is reducing its export quotas of rare earths because it wants companies to relocate to China in order to get the jobs associated with building the technologies that require rare earths. So far, big Japanese companies have rejected the idea of building factories in China to take advantage of the readily available supply of rare earths there. But Japanese firms may soon face a point where it’s either build factories in Japan or sign expensive off-take agreements with existing companies. What’s it going to be?
Luisa Moreno: The Japanese will definitely resist as much as they can to move into China, as that would mean sharing their patented technologies with the Chinese.
The Japanese are very conservative, and they always want to mitigate risk. They are putting in a lot of effort to find the right REEs project and they are obviously very much focused on projects that have HREEs.
Next year, we should see the Japanese getting more involved with projects in North America – assuming there is significant progress in those projects between now and then.
SmallCapPower.com: There is a cast of companies that amounts to the usual suspects in the rare earths space companies like Molycorp, Avalon Rare Metals Inc. (TSX:AVL), Quest Rare Minerals Ltd. TSX.V:QRM), and Lynas Corp. Ltd. (OTCQX:LYSDY). What are some small-cap REEs names that perhaps people haven not heard of?
Luisa Moreno: One small cap that folks might not have heard of is Search Minerals Inc. (TSX.V:SMY), which has a fergusonite deposit in Labrador. And then you have others like Montero Mining and Exploration Ltd. (TSX.V:MON). Montero has a REEs deposit in Tanzania. If you want to talk about companies that are very focused on metallurgy and looking to minimize capital expenditures, then Montero is one example. For now they have a relatively small REEs resource that they are continuing to work on to expand, and meanwhile they want to produce concentrates and oxides and start selling them as soon as possible, to establish a presence in the market.
SmallCapPower.com: What guidance would you offer a retail investor new to the REEs space?
Luisa Moreno: I would say do your homework. Most analysts, even the more senior mining analysts, have really never seen the birth of a group of elements like we are seeing today. For the investment community it’s almost like being in the Bronze Age, learning about new metals and exploring their applications and potential markets.
These elements are very new to investors and they are poorly understood. When you look at REEs companies and their projects, look at the important aspects like exploration risk, geopolitical risk… how adequate is the existing surrounding infrastructure and future transportation logistics? Given the unstable state of the global economy, do they have the necessary cash to continue to develop their projects?
Understanding the main elements in each project, their prices dynamics and market potential is important. Learning about the complexity of their metallurgy based on the number of and types of minerals in each deposit would also be helpful. Metallurgy is very, very important. So, spending some time understanding that I think is crucial.
SmallCapPower.com: Thank you for talking with us today, Luisa.
Interview Disclosure: This interview was conducted by Brian Sylvester on behalf of SmallCapPower.com. Mr. Sylvester and/or his family may own shares of the companies mentioned in this interview.
Luisa Moreno may/may not own shares in all of the companies mentioned in this interview.
Disclosure
Except for the historical information presented herein, matters discussed in this document contain forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from any future results, performance or achievements expressed or implied by such statements.
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