In 1967, when europium was integrated into TV sets to produce the color red, it was nothing short of a game-changer. And not simply because we were finally able to watch TV in color -- today, its cousins are used in a variety of applications such as smartphones, flat-screen displays, medical imaging, GPS navigation units, radar, night vision, missile components, DVDs, certain high-tech batteries and a number of other devices.
It's this increasingly growing list of applications, plus the ever-growing number of affluent users of them, that has investors clamoring for a way to profit.
I'm talking, of course, about rare earth elements.
Rare earth metals comprise 17 elements. And one should note, many of them are actually not all that rare. Gold and silver, by contrast, are much scarcer. The trouble is, while gold and silver are often found in large concentrations, rare earth metals seldom are, which makes it very difficult to mine them in a cost-effective way.
A stranglehold on supply... until now
Demand for rare earths is estimated at 135,000 tons a year. The U.S. imports functionally all of the rare earth materials used by industry every year. But here's the thing...
China currently controls most of the market.
Estimates vary, but all are above 90%, with some tallies putting Beijing's take at 97%. However, and this is a biggie, it does not have anywhere near that level of a stranglehold on the world's reserves, with only about 35%.
China is a leader in the market because its government subsidizes its production so as to encourage Western businesses to locate factories there. It also tends to look the other way when it comes to environmental concerns.
Mining these metals -- which are touted by green-energy champion President Barack Obama -- is a dirty, dirty, process. Their poor environmental record is the reason why rare earth metals have not recently been produced in the United States.
That was not always the case. In 1949, large amounts of rare earth metals were found in Mountain Pass, California. That mine alone was the primary source of rare metals in the U.S. from 1965 to 1985. The mine closed part of its operations after wastewater trouble in 1998, and operations were suspended entirely in 2003. The following year, a German company shut down a major plant in Elizabethtown, Kentucky, and the Japanese giant Hitachi closed a production facility in Edmore, Michigan, in 2005.
Now, let's keep in mind that while these plants are shutting down, demand is spiking. The iPod became a hot seller, then the iPhone, along with a host of other devices that required rare-earth elements. Then in 2005, China began to limit production and impose export tariffs on rare earth materials. Not surprisingly, prices started to rise. This begins to make policymakers nervous due to the myriad military applications of these metals.
This led to the Department of Energy developing its first-ever strategy concerning rare earth metals. At about the same time, HR 4866, the Restart Act, was introduced by a Colorado congressman. The purpose of the bill was to "reestablish a competitive domestic rare earths minerals industry..." It dies. Two years later, a miffed President Obama takes an unfair trade case against China to the World Trade Organization.
The resolution of that case is pending. China, which cut supplies to Japan after a maritime boundaries dispute, has said that it must limit production and exports so as to limit environmental damage. Although clearly a lot of malarkey, one sort of has to admire the chutzpah of the claim.
The outcome of the resolution is anyone's guess. In the meantime, other facilities are coming online to mine rare earths. The Mountain Pass mine in California has reopened, not to produce rare earths, but to refine the stocks it has already extracted. There are also major sources being tapped in Australia, Russia and Mongolia.
The easiest and best way to invest in this growing industry
There are not a lot of easily accessible investments in this space. Rare earth metals themselves don't trade on many major exchanges, and many of the biggest producers are global mining giants (and don't trade on U.S. exchanges). The best way is to own shares of Molycorp (NYSE: MCP), a $2.5 billion miner based in Colorado. This is the company that operates the Mountain Pass mine.
Management wants to restore the facility to its previous productive grandeur, and it has already fully funded the first two phases of its redevelopment. The first phase will bring some 19,050 metric tons worth of production online by the end of the calendar year, and by mid-2013, just six months later, Phase II will be complete. After that, the mine will be able to generate 40,000 metric tons per year -- roughly one-third of the worldwide supply. And Molycorp can not only extract it, but also complete "downstream" value-adds, like refining.
The absolute low-cost producer in rare earths
The real kicker with Molycorp is its cost structure. It costs the company $2.77 a kilogram to get the stuff out of the ground. That is less than half the $5.58 it costs the Chinese, and it's a fraction of the $10.11 it costs the Australian rare-earth miner Lynas.
A recent piece in the Financial Times pegged the cost of rare-earths at $121,000 per ton. Think about what that means. There are 2,204.6 pounds in a metric ton, which puts the retail price per pound at $54.88 and the net take per pound at $52.11 or $114,880 a metric ton. That's ballpark, but we'll go with it.
At an output of 40,000 metric tons per year, which we can expect in the next year, that's profit -- not revenue -- of $4.6 billion. And that's assuming rare-earth prices do not rise. Of course, they likely will: Apple (Nasdaq: AAPL) might be out of big ideas, but that's not going to stop it from selling a jillion iPad 3s.
And every one of them needs rare earth elements.
That level of profit would knock the cover off the ball for Molycorp, which had total revenue of $400 million last year. It also made $117 million in profit, which is a notch better than major mining outfits like Rio Tinto (NYSE: RIO).
Risks to Consider: The WTO case regarding China is not going to open up a flood of cheap exports. These metals are too precious to just give away, and the WTO isn't going to force China's hand. Clarifying the geopolitical issues might stabilize prices, but it is not going to crater them. But here's the beautiful thing. Even if that were the case, it would only serve as an all-the-more compelling reason to buy Molycorp at its current pricing and watch it profit from its coveted position as the low-cost producer.
> All in all, this is a company in the catbird seat. It has the raw supplies, the history of industry leadership and the tacit backing of the White House. It is also on pace to deliver a very rich revenue stream.
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