Rare earth metal miners were roaring this morning with many of the Market Vectors Rare Earth ETF component holdings up double-digit percentage points. On my daily volume breakout screen, 5 of the top 16 volume breakouts were in rare earth/strategic metals miners, including: China GengSheng Minerals Inc (CHGS), Avalon Rare Metals Inc (AVL), General Moly Inc (GMO), Rare Element Resources Ltd (REE), and REMX (the Market Vectors Rare Earth ETF itself). Those are just a few of the top volume breakouts across the U.S. markets. Here’s a list of holdings within the REMX ETF as per Bloomberg and their performance today:
Shares of many rare earth and strategic metals flew on Monday and Tuesday this week based on an announced rare earth mineral export quota cut from China, the largest producer of rare earth metals in the world. So what are the implications should the largest producer in the world restrict supply? Prices go up. It’s the same idea behind the oil cartels. Control the supply of a resource with inelastic demand and you have the setup to make substantial profits.
“China’s Commerce Ministry allotted 14,446 tonnes of quotas to 31 companies, which was 11.4 percent less than the 16,304 tonnes it allocated to 22 companies in the first batch of 2010 quotas a year ago.” (Source: Reuters)
Are Rare Earth Metals in a bubble?
On October 21st, Mark Smith, the CEO of Molycorp, was caught in a faux pas by calling the product his company produces, a bubble. “They (prices) are really spiked right now and there may be a bubble occurring because of all of the news and the frenzy.” He was referring to a short-term spike in prices last October in an interview with Fast Money on CNBC. He believes the long-term fundamentals will remain strong as China has made it clear they will continue to restrict supply; however, he believes that “when you see prices that are increasing by 600 or 700 percent in a 30-day period, you have to be very careful and make sure that you’re not making future business plans on those types of price increases.” This is the kind of prudent planning you see in the majority of resource company CEOs – it’s normal.
Short-term price spikes aren’t bubbles. They’re merely blow off excesses in speculation that drive up prices as supply gives way to the stronger of the two forces. Eventually, supply steps back in and you get a consolidation or reversal if demand has dried up. I think Mark Smith realized his mistake as his November 9th and December 21st interviews on Fast Money suggest he has reversed his comments, that there “isn’t a bubble in rare earth prices.”
The definition of a bubble, as defined in David Scott’s Investment Terms for Today’s Investor, is “a price level that is much higher than warranted by the fundamentals. Bubbles occur when prices continue to rise simply because enough investors believe investments bought at the current price can subsequently be sold at even higher prices. They can occur in virtually any commodity including stocks, real estate, and even tulips.”
All it takes to identify a bubble is common sense. Even though it’s clear to me that bonds are in a bubble based on net inflows into bond funds, the 30-year chart on interest rates, the debt levels of the United States, and inflationary expectations, it’s not clear when a bubble should or has burst until it has already happened. What I’m saying is, bubbles, trends, and bull markets can surprise to the upside and last as long as there’s somebody willing to pick up the tab at the end of trading. When the last dummy says, wait a second here, and a bid fails to appear, that’s when the game unravels.
Is there a bubble in rare earth metals? Well, the fundamentals are there. Everybody knows the story: China, producing 97% of the world’s production, is cutting that production and keeping it. What happens if China says, “Just kidding”? Well, then the game unravels, but until then…like Mark Smith said…China has made it clear they will continue to restrict supply; however, I hope you see just what the bull market in rare earth hinders on. If that fundamental story is gone, then the game unravels.
High rare earth prices are attracting investment outside of China. Supply will come on stream to meet demand. Capitalism demands it. China has a monopoly on production of rare earth metals, not the resource itself. World production was 124,000 metric tons in 2009. Molycorp said they’re currently producing 3,000 tons a year on existing stockpiles, but will ramp up when new ore from operations comes online in 2012. They are aiming for annual production of 20,000 tons by the end of 2012. Lynas Corporation is predicting it will plan 11,000 tons a year, but with further investment, they’re looking to double that production by the end of 2012. Unless China has plans to expand its production, while restricting it at the same time, China’s 97% market share on world production of rare earth elements will fall. Do you see the conundrum that rare earth bulls will be facing in a year or so?
Source: www.Nikkei.com
Do I believe that rare earth metals are in a bubble? The answer is yes as price is artificially being lifted by China’s control of the resource. For now, the fundamentals are pointing towards higher prices until market forces increase world supply to match China’s cuts. Because unless China stops cutting production as other production sights go online, they will lose market share and control.
The story behind buying rare earths at today’s price, is you believe China will make an announcement tomorrow, or the day after (metaphorically speaking), they’re going to cut supply again or demand will increase. Efficient market theory tells us that yesterday’s cut is already priced into the market today. It’s likely that China will continue to cut production over the next year. They will continue to have a monopoly for a while longer; however, capitalistic forces are clearly at work as Molycorp’s IPO in addition to Sumitomo’s investment nearly financed all of Molycorp’s plans to bring the Mountain Pass project back online. Lynas Corporation, about the same market cap as Molycorp, has plans to increase production as well. If supply increases faster than demand increases, price falls. It’s simple economics.
Rare earth mining is an area I’m invested in. The rare earth story has been out for a while since China announced plans to cut production of rare earth elements in April of 2009. So I’m not talking out of a bearish bias, having missed the run - on the contrary. I’m invested now, but eventually, I plan to get out when capitalist forces create enough supply to satiate demand. Natural gas at $11.88—uranium at $138—oil at $147; eventually, price demands supply. Just ask the Japanese steel industry how much rare earth gets smuggled out of China each year in their steel beams. Price always gets what it wants.
