- - Thursday, October 21, 2010

ANALYSIS/OPINION:

This week, fast-food stalwart McDonald’s Corp. delivered impressive quarterly earnings amid rising food costs. As I have mentioned previously, increasing commodity costs are one of the several things I have my eyes on. Normally when investors think of commodities, things like corn, wheat, soybeans, hogs, cocoa, lumber, gold, silver and coffee enter the mind. While those are key ones to watch, there are a number of others and a certain subset are getting all the attention.

What I’m talking about are rare earth elements.

Never heard of them? Well you are not in the minority, unless you happen to be in a high school or college chemistry class. That or you happen to look at the periodic table for fun. So let’s get some background on these rare earth elements.

As defined by the International Union of Pure and Applied Chemistry (IUPAC), rare earth elements or rare earth metals are a collection of 17 chemical elements in the periodic table — scandium, yttrium, lanthanum, cerium, praseodymium, neodymium, promethium, samarium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, ytterbium and lutetium.

Despite the name, rare earth elements are found in relatively high concentrations in the Earth’s crust, but because of their geochemical properties, they rarely concentrate into economically exploitable deposits. It’s from the rareness of the minerals in which these elements are concentrated and from which they are isolated that they have been named rare earth elements.

Until 1948, most of the world’s rare earths were sourced from India and Brazil, but this shifted in the 1950s to South Africa. Through the 1960s until the 1980s, the Mountain Pass rare earth mine in California was the leading producer. Today, the Indian and South African deposits still produce some rare earth concentrates, but they are dwarfed by the amount sourced in China. China represents more than 97 percent of the world’s rare earth supply.

These 17 rare earth elements are becoming an increasingly important part of our daily lives as their use in modern technology has increased dramatically over the years. Rare earth elements are now incorporated into many technological devices, including computers, superconductors, select types of magnets, electronic polishers, refining catalysts and hybrid-car components.

For example, there are nearly 10 pounds of lanthanum in every Toyota Prius engine. Other uses include luminescent materials used in optoelectronics applications, optical-fiber communication systems, cathode ray tube technology, tunable microwave resonators, and military technologies.

The increased usage over the past few years amid strained supply has raised concern over potential shortages of these key ingredients. In each of the past three years, China has reduced the amount of local rare earth production to be exported. For example, the total export quota for 2010 is 30,258 tons, down 40 percent from the 50,145 tons exported in 2009, and there has been some talk in the headlines that China may reduce export levels again in 2011.

In addition, China has made moves to buy other rare earth resources around the world. In 2008, Chinese-government-owned mining companies acquired 52 percent of Lynas Corp. and 25 percent of Arafura Resources, which plan to open mines in the next few years that would have a combined production equal to 25 percent of the global rare earth output. In September, China made political waves by blocking all rare earth exports to Japan, as the two nations were caught up in a spat after a Chinese fishing boat collided with a Japanese coast guard vessel.

Given the nature of these elements, the markets and products they serve as well as concern over China’s near monopoly position, the U.S. government is taking steps to help increase production of these elements. Last month, the House passed the Rare Earths and Critical Materials Revitalization Act, which supports the discovery and development of rare earth sites inside the U.S. Rep. Kathy Dahlkemper, Pennsylvania Democrat and author of the rare earth bill, said, “We need to act now to begin the process of creating our own supply of rare earth materials so the United States is never dependent on China for crucial components for our national security.”

This brings me to one of my investing themes — scarce resources. When people think of scarce resources, it tends to be oil, water or some other type. Based on the above, I would argue that rare earth elements fall into that category as well. Luckily, there are more than a few ways to play this from an investing perspective, some of which are easy and perhaps more transparent than others.

There are two companies listed on domestic stock exchanges — Molycorp Inc., which trades on the New York Stock Exchange under symbol MCP, and Rare Element Resources, which is listed on the American Stock Exchange under the symbol REE. Both are relatively new companies in terms of being publicly traded — Rare Elements since late 2008 and Molycorp this year. As such, there is limited history and operating performance that we can examine, but what is filed is readily available at www.sec.gov and must conform with generally accepted accounting principles. The same cannot always be said for other companies with rare earth element exposure that are listed on other exchanges throughout the world.

Other companies with exposure to these elements include Avalon Rare Metals and Neo Material Technologies as well as Great Western Materials, all of which are located in Canada. Chinese-based companies include Baotou Steel Rare Earth Hi-Tech, China Rare Earth Holdings and Jiangxi Copper.

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