The Death of China's Rare Earth Monopoly

Last week Molycorp (NYSE: MCP) bought Neo Material (TSX: NEM) for $1.3 billion.

The deal was heralded as a “rare earth game-changer.”

Here’s why…

If you remember, China controls more than 90% of the world’s supply of rare earth metals critical for production of advanced motors, batteries, weaponry, and electronics.

You can find rare earths in Apple’s iPads, Research in Motion’s BlackBerrys, Chevy’s Volt, Toyota’s Prius, and Raytheon’s Tomahawk missiles.

Prices for those metals soared in 2010 after China imposed export quotas, and any company calling themselves a rare earth miner climbed hundreds to thousands of percent.

A chart of Molycorp looked like this between its IPO in July 2010 and May of last year:

Then the steep run-up in prices coupled with continued fears of a global economic slowdown caused companies to cut their use of the metals…

Demand plummeted, taking rare earth prices along with it.

From spring 2011 through last week, Molycorp lost 68% of its share value and $4 billion of its market cap. Most other rare earth companies shared a similar fate.

Demand dipped so low that China only shipped 60% of its export quota last year.

Now lower rare earth prices and an uptick in automotive and electronics sales are starting to revive demand.

But Molycorp still had a problem…

Light on the Processing

There are two kinds of rare earths: light and heavy.

Last year, about 60% of Molycorp’s sales came from light rare earths like lanthanum, cerium, praseodymium, and neodymium.

With control of the 2,220-acre Mountain Pass mine in California that once met nearly all the world’s demand for light rare earths, Molycorp needed a way to access the heavy side of the business.

It also needed a way to get into the downstream processing side of the business. Rare earths need lots of refining before they can be used in motors and electronics, and Molycorp didn’t have that ability.

Their purchase of Neo Material gives them a bit of both — and shares of both companies surged on the acquisition news.

Reuters called the $1.3 billion deal a “rare earth game-changer” that would make Molycorp a “one-stop rare earth shop,” noting:

The bid for Neo will give it cutting-edge processing technology, expand its product portfolio and provide valuable magnetic alloy patents.

The move could also silence some of the criticism the U.S. company faces for being overly reliant on lower-value light rare earths like cerium and lanthanum.

The deal is strategic for Neo too, which, faced with dropping margins on feedstock costs in China, will gain a secure supply of raw materials.

As Byron Capital Markets noted, “Neo can do more business with Molycorp material than they can begging for Chinese feedstock.”

After the announcement, shares of Molycorp climbed 19% in a day, the most since going public.

Shares of Neo Material climbed 37% after the news.

The deal also sparked rumors that other rare earth acquisitions could be coming — and shares of Rare Element Resources (AMEX: REE) and Quest Rare Minerals (AMEX: QRM) climbed about 20%, while Lynas (PK: NYSCF) ticked up about 10%.

The rare earth industry has been a soap opera for the past two years, creating many new millionaires in the process.

The Next Rare Earth

I want to show you just the first question and answer of a recent interview with Jack Lifton, Senior Fellow at the Institute for the Analysis of Global Security.

Reporter: In the last five years, investors discovered lithium and the rare earths. What will be the next big thing?

Jack Lifton: The answer is graphite. Graphite has traditionally been considered a boring, mundane industrial mineral, evoking thoughts of pencils, golf clubs and tennis racquets. Investors should think again. Traditional demand for graphite in the steel and automotive industries is growing 5% annually, and graphite prices have tripled. New applications such as heat sinks in computers, lithium-ion batteries, fuel cells, and nuclear and solar power are all big users of graphite. These consumers are beginning to place substantial demands on existing production — and over 70% of that production is from China, which is no longer selling this resource cheaply to the rest of the world as the country’s easy-to-mine, near-surface deposits are becoming exhausted.

Graphite’s criticality and potential scarcity has been recognized by both the United States and the European Union, which have each declared graphite a supply-critical mineral. Recently, the British Geological Survey ranked graphite right behind the rare earths and substantially ahead of lithium in terms of supply criticality. Clearly, there is much more to graphite than pencils.

I firmly believe graphite miners are about to experience the thousand-percent run-ups witnessed by rare earth companies over the past few years…

But there’s only a handful to choose from, and you need to start staking out your position now.

Call it like you see it,

Nick Hodge

@nickchodge on Twitter

Nick is the founder and president of the Outsider Club, and the investment director of the thousands-strong stock advisories, Early Advantage and Wall Street’s Underground Profits. He also heads Nick’s Notebook, a private placement and alert service that has raised tens of millions of dollars of investment capital for resource, energy, cannabis, and medical technology companies. Co-author of two best-selling investment books, including Energy Investing for Dummies, his insights have been shared on news programs and in magazines and newspapers around the world. For more on Nick, take a look at his editor’s page.

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