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.