The Secret Ingredients of Everything

From smart phones to hybrid vehicles to cordless power drills, devices that our necessary for our national security and devices we all desire are made with a pinch of rare earths—exotic elements that right now come mostly from China. But not for long!!!!

Years ago when I began to educate myself about the workings of a stock market I had a dear friend, Edmund Handwerger that had been a trader his entire life. You who read me know I do not endorse anyone but in this case I will make an exception. Edmund had five sons, one of whom is Jeb Handwerger. Jeb is an internationally acclaimed authority on precious metals and rare earths. He can be found athttp://goldstocktrades.com/cmd.php?af=1333275 . I strongly suggest that you look him up and sign up for his 30 day free trial to his newsletter. Of all of the newsletters I subscribe to I find his to be the very best.

        When I told Edmund of my plans he gave me a list of books that were essential to my education. The first book he had me read was “The Great Crash of 1929” by John Kenneth Galbraith because he saw in 2004 that the same scenario that had played out in the 1920 would repeat itself. To borrow a phrase from Will Rogers, “History doesn’t always repeat itself, but it sure rhymes a lot.” When I think back to reading this book and in the subsequent years watching it play out as scripted, I am amazed at the similarities.

The second book I read was a book called “My Own Story” by Bernard Baruch. In the book he told a story of a college class he had taken and how this professor, George B. Newcomb had made a deep impression on young Bernard. Bernard Baruch attributes much of his later success to what he learned from Professor Newcomb. His mantra was “supply and demand.” To quote Professor Newcomb, “When prices go up two processes will set in – an increased production and a decreased consumption.  The effect will be a gradual fall prices. If prices get to low two processes will set in – decreased production because a man will not continue to produce at a loss and, second, increased consumption. These two forces will tend to establish a normal balance.”

          Well in the last two to three weeks we have seen this very description play out in the precious metals market and the mining stocks. Here is the way I saw it play out (and I believe it will continue to do so). As the dollar became stronger the ores and precious metals got too expensive to the buyers we were exporting to. This caused the buyers to stop exporting. When the exports were cut the stock naturally corrected to a lower level. In the last two days we have seen the dollar begin to weaken and the opposite thing happened. The precious metals were now less expensive so the export buyers came back and the stocks corrected back up to a more favorable level.  I created this diagram to make it easier for me to understand.

Stronger Dollar = More expensive exports = Lower stock price.

Weaker Dollar = Less expensive exports = higher stock price.

That’s the law of supply and demand in a nut shell and the truth is it drives almost every human endeavor.

If you took notice in the last few weeks you saw this play out as scripted.

          The dollar due to concern of another bailout in Greece, concern about Portugal and Ireland caused the euro to weaken and as expected the dollar got stronger. This caused Gold, Silver and all of our mining stocks to grow weak and sell off. There, of course, were other factors involved like the end of QE2 and what effect that would have on our economy and the Chinese slowly and quietly unloading their 1.1 trillion in Treasuries, uncertainty in the Middle East, growing unemployment and the overall malaise that I see in our economy. In the end however, I see it as a simple example of supply and demand. In the last two days we have seen the dollar grow weaker and it came as no surprise that Gold was up $15.00, Silver was up $1.50 and all of our mining stocks were up.

          Yesterday I read an article in the Wall Street Journal called “The Secret Ingredients of Everything”

From smart phones to hybrid vehicles to cordless power drills, devices that are necessary for our national security and devices we all desire are made with a pinch of rare earths—exotic elements that right now come mostly from China. I know I would not be able to locate Inner Mongolia, Jiangxi, or Guangdong on a map. Yet many of the high-tech devices we depend on like cell phones, laptops, and hundreds of others items would not exist without an obscure group of elements mined in those three regions of China.

Rare earths, as the elements are called, were discovered beginning in the late 18th century as oxidized minerals—hence "earths." They're actually metals, and they aren't really rare; they're just scattered. A handful of dirt from your backyard would probably contain a smidgen, maybe a few parts per million. The rarest rare earth is nearly 200 times more abundant than gold. But deposits large and concentrated enough to be worth mining are indeed rare.

The list of things that contain rare earths is almost endless. Magnets made with them are much more powerful than conventional magnets and weigh less; that's one reason so many electronic devices have gotten so small. Rare earths are also essential to a host of green machines, including hybrid cars and wind turbines. The battery in a single Toyota Prius contains more than 20 pounds of the rare earth element lanthanum; the magnet in a large wind turbine may contain 500 pounds or more of neodymium. The U.S. military needs rare earths for night-vision goggles, cruise missiles, and other weapons.

Now, rightfully so, a lot of people are worried. China, which supplied 97 percent of the world's rare earth needs, rattled global markets in the fall of 2010 when it announced that it would cut its exports by 37% and then a week later changed it to 50% and to add insult to injury they announce that any exports would include the paying of a 10% tariff. Over the next decade China is expected to steadily reduce rare earth exports in order to, maybe rightfully so,  protect the supplies of its own rapidly growing industries, which already consume about 60 percent of the rare earths produced in their country. Fears of future shortages have sent prices soaring. Dysprosium, used in computer hard drives, now sells for $212 a pound, up from $6.77 eight years ago. Over just two months last summer, prices on cerium jumped more than 450 percent. World demand will probably exceed supply before the end of 2012.

 Let’s face facts. We're in a supply crunch right now, and it's a pretty severe one, this year the demand will be 55,000 to 60,000 tons outside of China, and everyone's best guess right now is that China will be exporting about 24,000 tons of material. We'll survive because of industry inventories and government stockpiles, but I think 2012 will be a very, very critical year in terms of supply and demand.

The demand shows no signs of abating. In 2015 the world's industries are forecast to consume an estimated 185,000 tons of rare earths, 50 percent more than the total for 2011. So with China holding tightly to its reserves, where will the rest of the world get the elements that have become so vital to modern technology?

Although China currently monopolizes rare earth mining, other countries have deposits too. China has 48 percent of the world's reserves; the United States has 13 percent. Russia, Australia, and Canada have substantial deposits as well.

Until the 1980s, the United States led the world in rare earth production, thanks largely to the Mountain Pass mine."There was a time we were producing 20,000 tons a year when the market was 30,000 tons," says Smith. "So we were 60-plus percent of the world's market."

American dominance ended in the mid 1980s. China, which for decades had been developing the technology for separating rare earths (not easy to do because they're chemically so similar), entered the world market with a roar. With government support, cheap labor, and lax or nonexistent environmental regulations, its rare earth industries undercut all competitors. The Mountain Pass mine closed in 2002, and Baotou, a city in Inner Mongolia (an autonomous region of China), became the world's new rare earth capital. Baotou's mines hold about 80 percent of China's rare earths. Baotou, however, has paid a steep price for its supremacy. Some of the most environmentally benign and high-tech products turn out to have very dirty origins indeed.

Rare earth mines often also contain radioactive elements, such as uranium and thorium. Villagers near Baotou reportedly have been relocated because their water and crops have been contaminated with mining wastes. Every year the mines near Baotou produce about ten million tons of wastewater, much of it either highly acidic or radioactive, and nearly all of it untreated. The Chinese government claims it is making an effort to clean up the industry.

The government contends that it has already made strict regulations to protect the environment and weed out the backward techniques, equipment, and products. It has been reported that those factories without abilities of environmental protection will be closed or merged with bigger companies.

The world is now finds itself scrambling to find other sources of supply. Molycorp with its Mountain Pass mine will take up some of this slack but the problem is that MolyCorp produces light Rare earths and we need mines that produce heavy Rare earths. Lynas Corp in Australia which is building a separation plant in Malaysia is closest to becoming a producer but the people of Malaysia are concerned that they may get stuck with another environmental problem like they experienced in 1980 by Mitsubishi. Lynas is doing everything by the book but the people of Malaysia have heard this song before. They are still cleaning up the mess left behind by Mitsubishi 30 years ago. All due diligence is being followed by the Lynas team but doing things right takes time.

In the United States there is the project at the Bokan Mountain owned by Ucore, General Moly has the Mt. Hope project which hopes to receive their permits by the fall, and once they receive their permits they will own the largest undeveloped deposit of molybdenum in the world. Avalon, in Canada, has the Thor Lake project and Tasman Metals in Sweden has the Norra Karr project but all of these mines which will certainly take time to get permitted.

Unlike the Chinese, who are less squeamish about the permitting process of building mines, all of the companies I just mentioned “play nice in the sandbox.” I spoke to Seth Forman, head of Investor relations, with General Moly, Ron Malashewski, head of investor relations with Avalon and Peter Manuel, Vice President and CFO from Ucore and they all told me exactly the same thing. Obtaining the proper permits will take as long as it takes. There will be no cutting corners or getting around any procedures to “fast track” the permitting process.

As I write this I am long Lynas (LYSCF), Ucore (UURAF), Avalon (AVL), General Moly (GMO) and Tasman Metals (TASXF).

          Tomorrows post will be devoted to the Silver ETF (SLV). SLV has seemed to put in a bottom at $32.50 and I opened a very small stake at $33.50 but there are a lot of very smart people that have written there is a chance that SLV could go back and test the 200 day moving average at $28.00 so I want to take today to study this holding.  For those of you that follow my daily posts you know that I bought SLV @$26.50 in January and sold out at $47.50 on April 29^th and realized a 66% gain. The last thing I want to do is give it all back so I am practicing all due diligence because as the old cliché goes “lightning doesn’t strike twice.” Having said that there seems to be a greater demand for silver than there is supply, so I think Bernard Baruch would agree with me if I see another ride on the SLV train to $60.00 by the year’s end. I would rather miss the bottom by a dollar or two rather than get it wrong. I will also be posting a video of SLV on YouTube tomorrow. My YouTube name is “InvestingAdvicebyGeo”. Please take a look tomorrow.

Stay tuned for any updates and thanks for visiting.