Gold and Bonds Have Nothing on This Bubble

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Valuation guru Aswath Damodaran wrote in his book Investment Philosophies that "at the heart of most bubbles is a perfectly sensible story." The story surrounding rare earth minerals (also variously referred to as rare earth elements, rare earth metals, or just rare earths) is indeed a pretty compelling one.

Rare earths comprise a family of 17 exotic elements, including neodymium, dysprosium, and promethium. (Sounds like stuff you'd have to mine on Pandora, right?) These elements have many high-tech applications, ranging from lasers to magnets to batteries.

The military has a major interest in securing a reliable long-term supply, as do hybrid car makers like Toyota Motor (NYSE: TM  ) . Unfortunately for these parties, the supply lines are not at all well secured.

How we got here
In 1990, a single mine in Mountain Pass, California supplied around 40% of the world's rare earth needs. That mine was later mothballed, as lower-cost Chinese supply drove prices down to unprofitable levels. China now controls roughly 97% of the market for rare earths.

The rare earth story started to simmer a year or two ago, as new companies started getting their stories out (and old ones like Lynas found renewed traction, despite falling far short of past projections). Late in 2009, mining analyst and newsletter writer Mickey Fulp called the sector the "flavor of the year," and identified the bubble as such. That hasn't stopped him from participating in the early stages, though.

Fulp tapped Avalon Rare Metals and Rare Element Resources (AMEX: REE  ) as two of his favorite companies among those seeking to advance new rare earth deposits, and both have performed well -- particularly the latter, which has notched a multibagger gain since listing on the AMEX a few months ago. It wouldn't be a bubble without early successes like these. Mickey Fulp, a dude with a few decades of field experience, bagged some big gains here. The danger is that this lends confidence to generalists with no business investing in these niche ventures.

Falling export quotas and soaring stock quotes
In 2010, rare earths haven't lost their flavor. After a bit of a lull, investors are once again salivating.

China keeps ratcheting back its export quotas, which has a lot of parties fretting over supply shortages. Media outlets, from The New York Times to The Economist are all over the story.

Molycorp (NYSE: MCP  ) has capitalized on the situation by launching an IPO, the proceeds of which are being used to restart and expand the old Mountain Pass mine. The company took the asset off Chevron's (NYSE: CVX  ) hands for $82 million in 2008. Molycorp priced at $14 in late July, and notched a 10%-plus gain yesterday to close at north of $34, for a market value of $2.8 billion.

Rare Element, which has released an encouraging preliminary economic assessment on its Bear Lodge property in Wyoming, saw its stock shoot up roughly 20% yesterday -- a day that was downright hostile to other junior mining companies.

So, what exactly caused yesterday's spike? Well, following reports that China has blocked exports of rare earths to Japan for a few weeks running, officials are now saying that exports to the U.S. and Europe have also been halted. Japan apparently received retribution for detaining a Chinese fishing boat captain. Relative to that move, the one taken against the U.S. makes a bit more sense, when placed in the context of a growing trade dispute surrounding the clean energy sector.

You have an energy policy? Not fair!
The steelworkers union isn't too keen on China's support for "green energy" companies like Suntech Power (NYSE: STP  ) and LDK Solar (NYSE: LDK  ) . On Friday, the U.S. said it was launching a probe into unfair practices in the sector. China came out swinging over the weekend, saying the probe was "irresponsible."

I'm reminded of the line in Anchorman following a street brawl among several rival news teams: "Boy, that escalated quickly..." Let's hope the nations involved here don't let this dispute get too out of hand.

On standing in front of speeding trains
Circling back to rare earths, do I think that this trade flap increased the value of Rare Element's business by 20% overnight? Absolutely not. Will I bet against the company, then? No way. I've already been burned on a CAPS underperform call on Neo Material Technologies. With a very thin market and limited price discovery, the rare earths bubble is a very difficult one to call correctly, in terms of what "inning" we're in.

My plan, then, is to stand aside and let this one play out without me. I'll be sticking to producers of oil and other commodities where the geology and especially the pricing dynamics are somewhat easier to wrap one's head around.

Suntech Power Holdings is a Motley Fool Rule Breakers recommendation. Chevron is a Motley Fool Income Investor selection. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profileor follow his articles using Twitter or RSS. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (17)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 20, 2010, at 3:29 PM, foo1io wrote:

    I think there is a bubble in trying to predict the next bubble.

  • Report this Comment On October 20, 2010, at 4:29 PM, Acesnyper wrote:

    foo1ioi, I think you just made a profoundly well thought out statement.

    Everyone wants to jump into a bubble or make a quick dollar, the time and state of things now just ads to it.

    What's ironic is how a bubble on the theory of a bubble can make a real one. Not to name names but, maybe if we think back a bit an IPO that sort of ran out of... "juice" ok forgive me for that pun.

  • Report this Comment On October 20, 2010, at 6:01 PM, dlfleming2 wrote:

    You certainly can't own these rare earth stocks for valuation. They are pure speculation. I own several of them and are way up on most but feeling like I have a tiger by the tail. Obviously, I want to let my winners run but don't want to give it all back like has happened in the past. Call me crazy but I'm long MCP, REE, QSURD, ARAFF, AVARF, BRUZF, CREQF, DCHAF, GDLNF, GWMGF, LYSCF, NEMFF, QREDF, RAREF and TASXF.

  • Report this Comment On October 21, 2010, at 2:41 AM, puccini3005 wrote:

    Interesting how things come in pairs... This morning when I woke up I knew nothing about "rare earths". Then at work I went to a geological presentation, about global demand for these and other geological commodities. And tonight I find this article - its like you were there! I haven't checked out any of these companies yet, and it could well be that excitement has driven there stock prices to absurd evaluations... But from a demand perspective I think this is just beginning. It is certainly a sector worth watching and studying... and most likely waiting.

    Thanks for the great article, Mr. Shute.

  • Report this Comment On October 28, 2010, at 6:28 PM, cbsWTF wrote:

    Does anybody really see things getting MORE touchy feely with China? We are just starting to realize we are losing the trade war..dah. So we open the mines in CA and WY and F the Chinese. THe price may go down temporarily, but geopolitical battles -- Japan in the Kurgulins, US trade imbalance that will have to be dealt with one way or another -- China will use the export bans as a trade weapon more and more. Just the fact that prices have reopened the US mines suggest that the future is bright for REE et al.

  • Report this Comment On December 29, 2010, at 5:56 PM, pumpkinroo wrote:

    If you are going to play the sector it's obviously a good idea to focus on those companies in friendly territories. suggest your looking at CCE.V in British Columbia, I've been invested there for 6+ months and continue to hold

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