Despite a severe pullback in the prices of many rare earth metals mining stocks, constricting supplies and rising demand eventually will bring big profits to the select few companies sitting on rich deposits.
Prices for rare earths skyrocketed over the summer, but have since fallen - though nowhere close to where they were in 2010. That volatility was reflected in the prices of many mining stocks.
For example, one of the most heavily produced of the 17 rare earth metals, lanthanum oxide, was $5 a kilogram in early 2010. Lanthanum hit $140 a kilogram in July, then dropped 56% to $62 a kilogram in November.
"The rare earth prices were definitely in a bubble," John Kaiser, a mining analyst and editor of Kaiser Research Online, told The Critical Metals Report.
Meanwhile, the stock of companies like Molycorp Inc. (NYSE: MCP), the second-largest producer of rare earth metals outside of China, went from about $13 in mid-2010 to a peak of $79.16 in May, but has since fallen 58% to about $33.
The reason for the volatility is China, which mines 95% of the global supply of rare earth metals. When China announced it would cut rare earth exports by 40%, buyers panicked and prices spiked.
Meanwhile, the end-users of rare earths, which include smartphone makers, auto manufacturers and oil refiners, began to search for alternative materials while mining companies stepped up their efforts to locate and extract rare earth metals from deposits outside China.
Those efforts led to the recent price pullback. But with prices for the metals still much higher now than they were two years ago, mining rare earths is far more lucrative than it used to be.
Better yet, Kaiser said he sees market forces stabilizing with rare earth prices not far below current levels.
"That normalized pricing could make a lot of mining projects more economic than three years ago and technologies more practical than they are right now," Kaiser said.
Why Rare Earths?
Rare earth metals are suddenly in high demand for several reasons. For one thing, though they actually aren't all that rare, finding deposits concentrated enough to profitably mine is.
Add to that the complexities of extracting rare earth metals from the ore - it's difficult and requires costly processing equipment.
On the demand side, rare earth metals have unique qualities of immense benefit to manufacturers. In particular, rare earths have made it possible to shrink the size of many gadgets, such as smartphones. Without rare earths, smartphones would be the size of a brick.
As the world builds more and more things that rely on rare earth metals - from hybrid car batteries to tablet computers to fiber optics - uses for them will continue to multiply.
"Because of technologies discovering more applications for rare earths, it's very likely that demand will increase," Malcolm Gissen, portfolio manager at the Encompass Fund, which holds strategic-metal miners, told MarketWatch. "At the same time, the challenges in finding the metals and getting them into production are so enormous that prices will remain high. This is a good place to be invested."
Mining for Winners
Although there undoubtedly is plenty of profit to be made from mining rare earths, China's outsized influence on the market and the difficulty in finding and mining the metals means there's plenty of risk to go along with the high potential rewards.
In addition, many rare earth miners are small-cap stocks, and some won't survive over the long term. Some analysts estimate only 25 out of more than 250 public companies involved in rare earth mining have viable projects.
"This is a pretty volatile product," Ed Lopez, advertising director at Van Eck Global Fund, which launched a rare earth exchange-traded fund last year. "For somebody considering a long-term play, they need to consider what their time frame is and if they can tolerate the risk."
For those who'd like some exposure to rare earth mining stocks with the least risk, Van Eck Global Fund's Market Vector Rare Earths/Strategic Metals ETF (NYSEARCA: REMX)may be the best option.
The next step up is individual stocks, and here there are a few larger players. One way to mitigate risk with individual companies is with a miner that has operations outside of rare earths. Money Morning's Jack Barnes likes Vale SA (NYSE:VALE), the world's largest producer of iron ore and the world's second-largest producer of nickel.
For a pure play, there are two choices: Molycorp and Canada's Avalon Rare Metals (NYSEAMEX: AVL). Molycorp last month started mining at its Mountain Pass project near Las Vegas. Molycorp also announced that it would open a processing plant in California in early 2012, three months ahead of schedule.
Avalon's Thor Lake project has enormous deposits - 315 million tons of ore of relatively high grade.
For those willing to stray further from the United States, there's also Australia's Lynas Corp. (PINK: LYSCY). Lynas has experienced delays getting a Malaysian processing plant running, but it has a lot of high-grade ore.
Small Stocks, Big Rewards
Finally, there are the small players, which provide the most potential for profit and the greatest risk. Even within this group, though, there are few good bets.
Two small miners that have increased their odds of success by being early movers are Quest Rare Minerals Ltd (NYSEAMEX: QRM) and Rare Element Resources Ltd. (NYSE: REE), both Canadian companies.
Quest is on track to start production by 2016 at its Strange Lake deposit in Quebec and has a large portion of the less common and pricier "heavy" rare earths.
Rare Element is also on schedule to begin mining in 2016 at its Bear Lodge property in Wyoming, which is believed to be the second-best light rare earth deposit in the United States.
Money Morning's Barnes offers yet another alternative.
"The sector is so concentrated that it needs to be a shotgun approach," he said. "Basically you need to build a synthetic ETF. For example, you could create a position of 20% Vale, 20% Molycorp, 20% Lynas, and 10% each of some of the small caps."
David Zeiler is associate editor of Money Morning.