Rare Earths: What Next?

Addison Wiggin – September 29, 2011

  • The end of the rare earths boom? Not exactly… Byron King on how the landscape is shifting and why your strategy should too
  • Record-low mortgage rates, but can they apply the paddles to the housing market? A key number to watch…
  • What does the Dutch government have against people holding gold? Three events that add up to something worrisome…
  • Entrepreneurship made entertaining… Readers fret about derivatives and drones… and your last chance to join up with Byron King’s most elite readers

   “Rare earth prices,” Bloomberg reports this morning, “are set to extend their decline from records this year.” They’re officially declaring one boom we’ve been following with some enthusiasm of late… busted.

As your friendly publisher, we’re glad Byron King pulled the trigger on 178% gains in Molycorp when he did. But we’re also keen to suggest there’s more to the story… as we’ll show in today’s episode of The 5.

   It’s tempting to draw a similar conclusion to Bloomberg when you examine the recent performance of REMX, the rare earth ETF:

Indeed, the most abundant rare earths, cerium and lanthanum, could plunge another 50% in price over the next year, according to an analysis by Hallgarten & Co. in New York.

The reality is a bit more complex.

Put simply, the easy money’s been made in rare earths. Yes, China controls 97% of world production. Yes, China has clamped down on exports. But China can’t stop the users of rare earths from looking for alternatives.

“If you think you can keep raising the prices for those materials and still keep your customers, you’re crazy,” says Jack Lifton, one of the foremost experts on rare earths. “The principal customer for rare earth metals is a global automotive industry using rare earth permanent magnets. That industry will engineer this stuff out.”

   The recent rough patch for rare earth stocks was also fueled by a J.P. Morgan report on industry darling Molycorp, which we cited briefly a week ago Wednesday. In light of events today, it’s worth a closer look.

“What did the JP Morgan report say?” asks our own Byron King, who’s been onto the rare earths story since early 2008. “Not as much as you might think, really.

“The report noted that rare earth prices have fallen since July, which is hardly big news if you follow these things. The report also speculated that non-Chinese demand will fall in the near term, which is also hardly a state secret worthy of WikiLeaks.”

“The big revelation was that JP Morgan cut its price target for Molycorp shares from the previous $105 per share estimate down to $66. Still, to me at least, that wasn’t ‘news,’ because I never really expected Molycorp shares to get much above the $60 range.”

Indeed, Byron recommended getting out of Molycorp at $52.52 on Jan. 12 of this year… good for a 178% gain in four months. This morning, the stock is below $34.

   “Savvy investors are finished,” Byron writes by email this morning, “listening to stories about how some Canadian junior named XYZ Co., with four employees in Vancouver, has an ore body on the far side of nowhere.”

“Even if the Vancouver company has eight employees, and one of them was a chemistry major 25 years ago before he became a stockbroker, the mineralogy and geology stories are nice, but won’t get you anywhere. Not anymore. Doesn’t impress anybody.”

“Now, people want to hear about the metallurgy, at a graduate-level of chemistry, and not just arm waving. Investors want feasibility studies and engineering diagrams from serious laboratories.”

“That is, people want to know that there’s real chemistry and real engineering going on. ‘Show me the test tubes!’”

And “show me the application,” we might add.

   Twice this week, U.S. forces have launched attacks in Pakistan using drones:

  • A strike on a house near the Afghan border on Tuesday killed four suspected militants, according to local media. Two other people were wounded
  • A separate attack, also on Tuesday in the same region, targeted a vehicle… but it managed to flee before the hit, according to Agence France Presse.

By one unofficial count, there have been 53 drone strikes this year in Pakistan. Two years ago, 53 was the number of drone strikes carried out by the U.S. military worldwide. Last year, that total more than doubled to 118.

   It may be that drones are what Barack Obama believes will help him cut the Gordian knot of South Asia.

As legend has it, an oracle told Alexander the Great if he could untie the Gordian knot, he would rule all of Asia. Alexander cut the rope with his sword, and the rest was history. He got as far as modern-day Pakistan.

“There his exhausted troops rebelled,” recalls syndicated columnist William Pfaff today, “and his retreat from Asia began. The oracle should have known that the mastery of Asia ultimately belongs to Asians.”

But that won’t stop the president from trying.

The United States has now carried out drone strikes in six countries that we know of: Pakistan, Afghanistan, Iraq, Libya, Yemen and Somalia. Drone strikes were carried out against the Somali rebel group al-Shabaab only last weekend.

As the U.S. military expands its “footprint” around the globe, to use Pentagon lingo, drones will be undoubtedly play an exponentially growing role.

   One pauses to wonder: Why does an “anti-war” president condones the use of drones in otherwise undeclared war zones? Perhaps it’s because of their “unique capabilities”: Drones are politically sanitary. Dehumanizing, sure. But for better or worse, they allow covert operations to be conducted from long distances without putting U.S. troops in harm’s way — the only political cover a president needs.

Their use will only proliferate from here… and the technology will only evolve. Do what you will with the forecast.

   Drones couldn’t operate were it not for a lightweight-but-super-strong metal that Byron King has taken of late to calling “the fourth element.”

Beryllium is six times as strong as steel, withstands extremely high temperatures and has a high resistance to rust. Alloyed with aluminum, beryllium achieves even greater feats… and one company that Byron has been following this year has pulled off just that.

“It’s a true breakthrough in military technology,” he explains, “contributing hardness, strength, high electrical and thermal conductivity, and resistance to wear and fatigue to U.S. fighter jets and other vital weapon systems.”

Two days ago, this company signed a drilling deal to begin the process of extracting large quantities of beryllium from a site in the Western U.S. It’s a real-world example of “vertical integration” — pulling the stuff out of the ground and then using it to create materials to sell to a host of industries.

Among the applications Byron cites: “Nuclear, aerospace, defense, telecom, computing, electronics, medical, automotive, oil and gas and many more.”

Right now, the company’s market cap is a minuscule $42 million. “It would take only a tiny chunk of the defense budget’s $707 billion spending spree to well exceed this Canadian company’s small $42 million market cap.”

Byron reveals the name and ticker symbol of this stock to new members of Energy & Scarcity Investor… still available through midnight tonight at a handsome discount. Check it out here.

   Stock traders again lost their senses today. But a 134-point rally, thus far, on the Dow doesn’t really make up for the 175 lost yesterday in a late-day mini-panic, does it?

Chalk up the meager gains to relief that Germany’s parliament approved an expansion of the eurozone bailout package.

Heh.

There’s also cheer in the pits over the weekly numbers on unemployment claims. At 391,000, they’re down substantially from the previous week’s 428,000.

Not that either number is an indicator of a robust economy, but there you have it.

   “The negative character of the behavior of market price is acting like a dark cloud over the market,” wrote Options Hotline editor Steve Sarnoff to readers last night.

For now, “Sellers have retained their advantage and we are looking at the likelihood of lower prices to come.”

   After another trip below $1,600 overnight, an ounce of gold fetches $1,613 this morning. Silver tumbled below $30 overnight, but has since recovered to $30.48.

   Our friends at GoldMoney have reluctantly decided to close the accounts of all their Dutch customers.

“Even though we are regulated by the Financial Services Commission in the island of Jersey, where we operate,” says founder James Turk, “the Dutch regulator was requiring that we also be regulated by them. So for now, closing accounts for people resident in Holland was the only practical solution.”

The problem revolves around the arcane issue of whether GoldMoney’s offshore storage of gold constitutes an “investment object” under Dutch law.

Ordinarily, we’d chalk that up to bureaucratic idiocy… but then we recalled our story from last winter about the Dutch pension fund forced by central bankers to divest three-quarters of its gold holdings because gold was considered “too risky.”

And a couple of weeks ago, the head of the Dutch Socialist Party sent a letter to the nation’s treasury secretary, asking, among other things, where the central bank keeps its gold, and whether any of it’s been loaned out.

Hmnn…

   Even fewer Americans are signing contracts to buy homes than was previously thought. The National Association of Realtors (NAR) index of pending home sales fell 1.2% between July and August.

Perhaps the 60-year low on mortgage rates is not low enough? A 30-year fixed goes for 4.01%, according to your pals at Freddie Mac. And at 3.28%, a 15-year fixed is also at a record low.

We’re not going too far out on a limb to say that even if rates go lower, buyers won’t be flooding the market and propping up home prices. Not unless the aforementioned first-time unemployment claims fall into the low 300,000 range.

The last time that happened? November 2007… just before the “official” recession began.

   The Commerce Department is out with its final guess at second-quarter GDP — an annualized 1.3%.

Combined with the first-quarter’s 0.4%, that works out to a 0.85% pace for the first half of 2011.

The “expert consensus” of 80 economists polled by Bloomberg is counting on 2% growth for the second half. We’re not.

   On occasion, we’ve pointed to research at the Kauffman Foundation that shows how startup businesses are responsible for nearly all new jobs in the United States.

No matter how many times Kauffman points that out, the research is a little, well, dry. No more… Kauffman debuted its “sketchbook” this morning. It’s an animated whiteboard drawings narrated by CEO Carl Schramm and it’s worth a look:

Among the points it makes creatively: Of the 3 million new jobs that are created in a typical year, nearly every one is at a firm that’s been in existence five years or less. Maybe the drawings will actually make sense to the children at the playhouse on Capitol Hill.

Perhaps a bit of it will end up in our entrepreneurship documentary RISK! The latest rough cut of which will be seen by a select group of Reserve members visiting us in Baltimore two weeks from tonight. Stay tuned…

   “It’s not the poor Arabs the Pentagon’s watching” with drone aircraft, a reader warns, commenting on this curious trend we’ve identified linking drones, military aircraft and the rare earth investing space, “it’s all of us too!”

“Welcome to ‘SkyNet’ in the Terminator sequels. The government already possesses the power to rain fire down from the sky. Who needs the mythical dragons?”

The 5: Is it a stretch to suggest you invest in the raw materials these warmongers are consuming at an accelerating rate? The very thought of it sent fits around the table at our editorial meeting this morning.

   “One wonders at U.S. priorities and diplomacy,” writes another reader, reflecting on the use of drones. “We supply Turkey with drones to use against Kurdish rebels and voila! we lose our only strong ally in Iraq — the Kurds.”

“Our government seems determined to alienate just about everybody on the planet.”

The 5: Even readers of The 5.

   “Why are you worried about a few thousand heat seeking missiles?” writes a reader after yesterday’s issue. “I agree that if they fall in the wrong hands (and they will) that will be a problem (which, as you say, will mean bigger budgets for spooks).”

“The bigger issue I see is when Taiwan reverts to China (and it will) and all those U.S.-sourced weapons and systems will be given and come willingly into the hands of the Chinese military. Not that that in itself is good or bad — I make no judgment on that — but I can imaging the hand-wringing in the Pentagon and CIA and they realize ‘we did it again’!”

The 5: Don’t forget that Pakistan is moving closer to its old ally China these days as it drifts away from the United States… while the United States cements an alliance with China’s archenemy India. More about that tomorrow…

   “What boggles the mind,” writes a reader about derivatives, “is that those numbers aren’t billions, they’re trillions! America’s GDP is only $14 trillion a year.

“In a quick paragraph for the ignorant, how do derivatives work? In layman’s terms, are these derivatives essentially a bet on top of bet on top of a bet by a few rich people and too-big-to-fail banks just looking to make a fast buck?”

“And when it blows, Main Street (mom and the kids) picks up the pieces of Wall Street (the drunk and gambling husband/dad who loses everything)? Do the Republicans and/or Democrats believe that this is capitalism? Why is this stuff legal?”

The 5: You know more about derivatives than you give yourself credit for.

Cheers,

Addison Wiggin
The 5 Min. Forecast

P.S. Last chance: The half-price membership offer for Byron King’s premium advisory Energy & Scarcity Investor expires tonight at midnight. If you’re so inclined, take advantage here.

rspertzel

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