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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Lessons From The Failed Rare Earth Investment Hype

Lessons From The Failed Rare Earth Investment Hype

The story of the Rare Earth Elements (REE) boom is one of the most disappointing but valuable parables for investors today. Rare Earth Elements were supposed to represent a sort-of new millennium gold rush that would bring big profits to investors and increased national security for the United States. Neither aspect of the story has worked out the way it was supposed to.

REEs are a series of minerals found in the earth’s crust that are important for producing high tech electronics and for use in industrial processes. For example, one of the most common uses for REEs is in magnets. REEs are not all that rare, but usually they are not concentrated in large veins of minerals the way iron, copper, gold, and other minerals are. Thus, the scarcity of economically viable deposits is what classifies these minerals as ‘rare.’

REEs were not a well-known commodity until a few years ago, when a 60 Minutes report and a spat between China and Japan brought them to the surface of public attention. China produces most of the world’s REEs, and after a territorial dispute between the Chinese and Japanese, China banned REE exports to Japan. China’s attempt to weld its disparate group of small REE miners into an effective monopoly startled the markets and led to massive price hikes across the REE space. Related: Alberta’s Government Kicking Oil Industry While It’s Down

Then economics set in.

China never had a real monopoly on REE production. The country’s REE mining industry is made up of numerous small firms, which makes any unified action among those firms next to impossible. But after the REE price spike, all of the firms in China rushed to increase production. And many firms around the world did the same thing. As production spiked, prices fell dramatically, and many firms that were once optimistic about potential profits found themselves selling a very oversupplied commodity.

Now that the dust in the REE market has settled, there are not many investible companies left. Most of the mining is done in China, but even those firms are generally small and not suitable for most investors. Outside China, some of the biggest REE firms include Australia firms Iluka and Lynas. In the U.S., the only major dedicated REE miner is Molycorp. Related: Is Saudi Arabia Leaving The U.S. Behind For Russia?

But Molycorp has been an unmitigated disaster for the vast majority of investors in its stock. The company sunk from a market capitalization of $6 billion in 2011 to less than $100 million by June 2015. Despite having the only operational U.S. REE mine, Molycorp has been unable to make a profit as REE prices continue to decline and its own processing costs remain high.

The company declared Chapter 11 bankruptcy in late June 2015. Given the high cost of processing REE materials and the continued fall in prices, it’s questionable if Molycorp can ever live up to investor expectations even if it manages to cut its debt load and emerge from bankruptcy.

Whatever entity emerges from Molycorp’s bankruptcy will likely be a profitable and investible business only if it is focused on the firm’s distribution subsidiary known as Neo, the profitable part of the company. That is an issue investors have plenty of time to consider though, as the firm’s bankruptcy is just starting. Related: Bakken Production Remains Firm In Spite Of Low Oil Prices

Australian firm Lynas was once considered a hot investment option like Molycorp. Unfortunately for investors, Lynas has faced the same headwinds as its American competitor, and its ultimate fate may be the same as well. Lynas’ stock has declined precipitously, and while the firm was able to attract some distressed equity investors in June 2014, that cash doesn’t change the market situation. In light of the unattractive economics in the space, Lynas is not a good investment option for investors at this stage.

Of all the rare earth producing companies, Iluka is the only one that might be worthy of investment consideration, and even here the company is battling the same market uncertainty. Iluka has a number of interesting mining properties, and some of these properties offer low cost mineral development options in attractive growing geographies.

The lesson for investors in the rare earths parable is that the conventional wisdom is not always right. Economics – in particular supply and demand – are the long-term drivers of profitability. China’s rare earth’s monopoly has been proven to be little more than a paper tiger, and investors who jumped on board the “next big thing” without a close examination of the fundamentals underlying the market found out the hard way that hype only lasts so long.

By Michael McDonald for Oilprice.com

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  • Thomas Crown on July 12 2016 said:
    Renewed tensions between China and Japan recall the 2010 REE crisis as I could read in todays research by www.rockstone-research.com/index.php/en/research-reports/1244-REE-Boom-2.0-in-the-making
    I would be more than grateful for an up-date and the authors view on Lynas, Niocorp and Commerce Resources, recently funded by the Quebec government.

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