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Jon Hykawy Sees Downstream Value in Rare Earths
Source: Brian Sylvester of The Gold Report (11/26/10)
Byron Capital Markets Analyst Jon Hykawy sees the rare earth elements (REE) sector for what it is—something much different from mining copper or gold. He believes the keys to making money in rare earths involve metallurgy, deposit location, marketing and downstream integration. In this Gold Report exclusive, Jon makes his case for rare earth elements and the companies he believes have the best chance to deliver them at a profit.
Joining Hykawy on the panel were REE specialist Dr. Tony Mariano and Ford Motor Company's Ted Miller.
Hykawy stressed that the weight-saving and heat-dissipating qualities of rare earths are critical to building battery magnets and the light engines that travel the maximum distance on a single charge.
A significant psychological barrier to prospective hybrid and electric car buyers in North America, Hykawy argued, is the idea that electric cars won't let folks pack up the car and drive half way across America, even if few consumers would ever actually attempt that.
But Hykawy believes the real growth in hybrid and electric car sales will come from Asia, especially China.
"In China, you're competing against people who are taking their bicycles or walking to work," Hykawy explained. "For them, a huge selling point is having a small box around them in a light vehicle that can carry them to work on a single charge. That way, they're not putting three-quarters of their monthly income into diesel fuel."
Lots of Metals
"A lot of what you see in the mainstream media lumps rare earths into one category. That's an error. Don't fall into the trap of looking at REEs as one material. This is not copper. This is not gold. As Tony said, depending on who is counting and what's included, there are between 14 and 16 elements that get included in this group of rare earths and only a few of them are required in magnets," Jon said.
In his view, those elements are neodymium, samarium, praseodymium, dysprosium and terbium.
Dysprosium and terbium are alloyed into rare earths magnets to make them capable of operating at elevated temperatures. At current alloying levels, dysprosium and terbium make up about 5% of the metal used in these car battery magnets.
"Unfortunately, most of the rare earths deposits out there don't contain those levels of dysprosium and terbium. We think they are going to be in tight supply and probably significant undersupply," he predicted.
Jon says that mineralogy and radioactive content are two of the biggest factors in determining an economic deposit. "Mineralogy because if you can't get the material out economically, you don't have a mine," he said, adding, "With all due respect to the geologists in the room, they may find some rock and they may even fall in love with their rock but that doesn't make it a business."
Many rare earths deposits contain radioactive elements like thorium and uranium, potentially costly byproducts.
"If you have no solution for storing (radioactive elements), then you have an expensive problem," he stated. "If you have a solution for storing them, then you may have something that's far better than a byproduct. You may have a business that you can use to take other people's problems and solve them for them."
The China Factor
"Not only do you have to produce the right stuff. You have to worry that other people could destroy your economics," Jon warned, "and that includes the Chinese acting into the market because they will. You can almost count on it."
By some estimates, China controls about 97% of the global production of rare earths.
After reducing its rare earths exports earlier in 2010, last summer the country said it would further reduce rare earth exports by 30%. Under the threat of a visit by U.S. Secretary of State Hillary Clinton, China relented and said the quotas would remain at current levels in terms of tonnage.
But China's quota system has resulted in supply gaps. Lumping all the rare earths into one giant quota has meant that the most expensive REEs are being exported first. It only makes economic sense. Would you rather export lanthanum at $10 a kilogram (kg.) or heavy rare earth elements (HREEs) used in high-tech magnets at $1,500 a kg.?
The economics of China's current export quota system, for example, has left the country with too much lanthanum and the rest of the world with too little.
"China will probably fix that by establishing segregated quotas. It will put in a quota system with a cap for lanthanum and cerium. It may have a separate quota for the medium heavy rare earths used in magnets. And then maybe a separate quota for the very heavy rare earths," Jon explained, adding "There is a concerted effort going on in China to really grab this industry by the neck and use it as a means of control. And that goes back to the segregated quota system because, although (China) promised the United States and Europe the tonnage wouldn't change, it didn't say the composition of that tonnage wouldn't. So, by introducing a segregated quota system, you could conceivably shift almost all the shipment allowance to lanthanum and cerium, which are of no use in building these electric vehicles. Furthermore, you would actually decrease quite markedly the amount of magnet material and the amount of HREEs that leave the nation."
China's ultimate goal, Jon said, is to move technology and jobs in a growing industry into China.
"(China is) fighting both the time that it will take Molycorp Inc. (NYSE:MCP), Lynas Corporation (ASX:LYC) and Great Western Minerals Group Ltd. (TSX.V:GWG; OTCQX:GWMGF) and a number of other companies to get to market with their own (rare earths) production outside of China, as well as a corporate spending cycle. A corporation might decide that it's in its best interest to move production to China but that company has to wait a year because the budget cycle is over."
Market for Vanadium
"Vanadium, we believe, is the best cathode material that can be used in these automobiles. And we're starting to see that conjecture being borne out by the battery industry, which is looking at lithium/vanadium/phosphate cathodes as one of the more important drivers for a higher-power, higher specific-energy battery and, potentially, a much less expensive battery for the automotive industry down the line," Hykawy said.
Lithium/vanadium/phosphate cathodes are cheaper than lithium/cobalt/oxide cathodes, which are commonly used in laptop batteries. Lithium/vanadium/phosphate cathodes are cheaper because vanadium costs less than cobalt; and these cathodes have a higher "specific energy," so they can store more power than similar chemistries.
Jon compared lithium/vanadium/phosphate batteries with the lithium/manganese-oxide batteries used in General Motors' Chevrolet Volt and Nissan's Leaf. The charge-discharge rate for the latter is 10C, whereas lithium/vanadium/phosphate batteries have a charge-discharge rate of nearly 50C. That means you can charge the battery faster, which makes them very attractive for use in electric cars and laptops.
"We view (lithium/vanadium/phosphate batteries) as having a very, very attractive chemistry and probably the next generation of automotive batteries. That would be a significant demand driver for vanadium moving forward," Jon predicted. He noted that Subaru and China's BYD Auto are currently working on lithium/vanadium/phosphate batteries for various uses.
Rare Earths Companies
"We are definitively in a bubble as far as the rare earths stocks are concerned, Jon asserted, "and I say that because they are all moving up at this point. They are moving up whether or not there is a good resource and a good deposit behind them. "If you go look at the research on our website, we have sells on a number of rare earths companies."
But he still sees some value in the sector.
"Unlike mining other metals," Jon noted, "there is great value in being vertically integrated. The oxides produced from solvent-extraction plants can be sold at a good profit. The real money lies in taking those oxides and making them into metals, and then making those metals into things like magnet alloys and magnets. "We like to see these companies moving downstream as far as is practical. For instance, one company we cover, Great Western Minerals, goes all the way down the line to actual alloy production and it sells to companies in Japan," Hykawy explained.
The rare earths business is as much about marketing as it is about mining. "These are industrial materials. You really need to produce the products at a quantity and at a cost that the customer demands. And that's marketing," he said.
Great Western owns a share of the past-producing Steenkampskraal rare earths mine held by Steenkampskraal Monazite Mine Pty. Ltd., a 74% owned subsidiary of Rare Earth Extraction Co. Ltd., or Rareco, which is based in Stellenbosch, South Africa.
Great Western owns about 21% of Rareco. GWG also has a 10-year agreement for all the rare earths produced from Steenkampskraal.
The mine was placed on care and maintenance when China made a big push into rare earths in the early 1990s. Since then, Steenkampskraal has been used as a licensed repository for thorium—a radioactive byproduct of producing REEs and titanium.
Jon believes the repository will eventually act as a radioactive storage facility for miners in the area—for a fee, of course.
"There is an awful lot of monazite in the area. Monazite is essentially a mineral that contains thorium and rare earths. A lot of the monazite producers are going to have to find a storage solution like Steenkampskraal," Hykawy said, "there is monazite produced as a byproduct of titanium mining, and the titanium miners would like nothing better than to hand over this problem to someone else. There are also other rare earths mines being developed in the area and they, too, will have a thorium problem."
Jon says GWG should be in production by late 2012. Dacha Capital Inc. (TSX.V:DAC; OTCQX:DCHAF) is another company Jon likes, albeit for much different reasons. "Dacha is a very interesting model because you can look at buying only the rare earths that you believe are going to be in short supply. For instance, you can stockpile only dysprosium if you think dysprosium is a commodity that's going to be in short supply," Hykawy said.
"The model is a good one. You don't have to establish a mine. You just have to have someone who is willing to sell rare earths to you at market rates. And if you hold it long enough and you're right in your conjecture that those are the REEs that are going to get pricey, then you're going to make a lot of money on this stuff," Hykawy said. "The drawback up until recently was that the market had treated it like an ETF and the stock traded at a discount to net asset value (NAV). But that's been rectified."
Dacha, a company under the Forbes & Manhattan banner, is based in Toronto but operates several warehouses in Southeast Asia that serve a steady client base in Japan. Hykawy believes the business could get much larger as more companies require on-demand rare earths.
"As long as (Dacha is) the one with the leverage, they could become something of a clearing house for rare earths," Hykawy said.
Rare earths are emerging from their traditional status as obscure metals that are difficult to pronounce.
When China announced that it would further reduce rare earths exports, the story made The New York Times. The article discusses some American solutions to the problem, including Rare Element Resources Ltd.'s (TSX.V:RES; NYSE.A:REE) Bear Lodge project in Wyoming.
"We like the deposit. The infrastructure advantage it has is amazing. The company is in a location where there is good support available to the project. It's not in an unoccupied part of the world where you're going to have to move everything in," Jon explained. "It's a U.S. project, and America wants an American solution to this. This is actually a very good project. Rare Element has a reasonable amount of HREEs in that deposit. You may well see merger and acquisition (M&A) activity in this space over the next little while and the company would make a very interesting acquisition for people."
Hykawy said the recent surge in the share prices for rare earths companies like Rare Element are not likely to retreat soon.
"We are maintaining all of our recommendations at this point because, frankly, there is a freight train behind this and I don't think the freight train is done yet. Rare earth prices will likely continue to move up and the stocks are likely to continue to move up, too."
Jon Hykawy is currently with the Research team at Byron Capital Markets, with a specialized focus in the lithium and clean technology/alternative energy industries. Jon holds both a PhD in physics and an MBA from Queen's University and has been working in capital markets as a cleantech/alternative energy analyst for the last four years. He began his career in the investment industry in 2000, originally working as a technology analyst. His current area of focus is the lithium sector, ranging from availability and production to lithium battery technology. He has extensive experience in the solar, wind and battery industries, conducting significant research in the areas of rechargeable batteries, ranging from rechargeable alkaline to lithium-ion to flow batteries. Jon is also fluent in Spanish and Ukrainian.
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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None
2) The following companies mentioned in the interview are sponsors of The Gold Report: Dacha, Great Western and Rare Element Resources.
3) Jon Hykawy: From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.