Strategy Metals Bulletin (52)

Aims to update investors on developments in the world of strategy metals – crucial inputs to industry, defense and technology innovation

Terence van der Hout                    
Nov 13 – 19, 2011 Gold&Discovery Fund

The 7th Hong Kong Rare Earth Conference was a packed affair, and a changed presentation line-up and attendance crowd underlined the road to adulthood the REE industry is currently undergoing. Presentors now came from various industry end-users, research and innovation labs, and China, as opposed to the usual weste gurus and junior hopefuls that line the Canadian shows. A number of myths were busted, others upheld, and forecasts and developments in the various segments of REE applications were more detailed and granular. I will review a number of interesting speeches over the next few bulletins. This week I will focus on the opening presentation by Constantine Karayannopoulos, CEO of Neo Material Technologies (NEM.T).

Neo Material Technologies
Neo Material is a major processor of rare earth materials, producing 85% of the Chinese market for the all-important magnetic powders. These powders are used to make high performance magnets which in tu are input to all hard discs, mobile phones, automobiles and various green tech innovations such as wind turbines etc. The rare earth industry is said to be driven primarily by magnets. Neo Material Technologies (as well as its European counterpart Rhodia) is therefore at the heart of the rare earth industry, and comments from the company are generally worth listening to. Mr. Karayannopoulos went on a myth-busting tour and made a number of interesting comments on developments in the markets.

Myth number 1
Myth number one is the generally accepted truth that China’s low cost production in rare earths that drove out inteational competitors at the beginning of the millennium was due primarily to its dismal environmental regulation and low labour costs. In fact, China’s environmental regulations are stricter than almost anywhere else in the world, and the standards themselves are not an issue. It is in the enforcement that things are going wrong in China, and this makes me wonder if the increased recent regulation in terms of invoice systems, production quotas, attempts at price controls, centralization, and five year investment and innovation targets that are sending shivers down the spines of free market adherents are going to be effective if the same level of commitment is not given to enforcement. There are no free markets in rare earths, as readers probably know by now, and I guess rigid and expensive enforcement is a necessary burden on those seeking to monopolize.

Mr. Karayannopoulos believes that it is particularly the fiercely competitive nature of the numerous inteal domestic REE operations that has lowered costs in China over the years. Also, given the by-product nature of rare earths at Bayan Obo (the largest rare earth mine in the world is primarily an iron mine), production of rare earths is virtually free because capital expenditures and operational expenditures are boe by the iron production. How do you compete with that. A third reason for the low costs is in the randomness of geology, which has dictated that the rare earths in China are easily extractable and separable, implying low processing costs. Finally, innovations in the field of chemistry has given an advantage. In China, operators were able to successfully transfer from the use of nitric acid to the much cheaper hydrochloric acid as a means of extracting the elements from their minerals.

Myth number 2
Myth number two that was presented by Mr. Karayannopoulos, conces the widely accepted idea that rare earths are irreplaceable in their various applications. Because of their unique characteristics, there are no substitutes at any price for REE in technology. Well, this world view is changing, and in a number of fields REE are being replaced as a logical consequence of input prices rising from say $3 per kg to $125 per kg over a two year time-span. In the cases where end-products are a commodity rather than a specialty, price prevails over performance, and substitution is a necessary development. Price-conscious producers are being forced to substitute with cheaper inputs that have acceptable poorer performance. A lot was said on what I would call the de-commoditization of rare earths during the conference, and I will come back on this in upcoming articles, as to me this presents the core of where rare earth markets are headed for the coming years.

Mr. Karayannopoulos then tued his attention to innovations focusing on efficiencies in terms of volume-reduction of the now high priced rare earths. Shin-Etsu, a large Japanese magnet producer, has focused on significantly reducing the input of dysprosium in their newest NdFeB sintered magnets, and have been able to engineer the hugely expensive terbium completely out of the magnet, apparently at no loss to performance. Rather than being a threat to the demand for rare earths, I view these kind of developments as a very natural part of innovation cycles, and is a driver of efficiencies. This is not reducing the need for rare earths, but rather structural shifts in the supply and demand parameters per separate element.

Market developments: lagging demand
According to Mr. Karayannopoulos, weakness will prevail in the non-Chinese demand for rare earths in the short to medium term. Japan’s Fukushima disaster has impacted all industrial production and therefore demand for these inputs. Japan, needless to say, constitutes a large part of demand for processed REE in concentrates, powders and alloys for their automotive and high-tech industries. Adding further to the depressed REE markets are the recent floods in Thailand, where most of Neo Material’s non-Chinese clients are situated. Hence, Mr. Karayannopoulos sees the FOB prices of dysprosium, cerium and lanthanum dropping further over the next couple of quarters.

Market developments: lower ROW demand will drive 2012 export quotas lower
Mr. Karayannopoulos estimates that total demand outside of China (ROW) amounts to roughly 40,000 tons REO per year. We know that 30,000 tons are covered by the quotas, implying the remaining 10,000 tons is presumably covered by smuggled ware. Given the fact that demand has slumped significantly, Mr. Karayannopoulos believes that despite the recent global outcry over diminishing Chinese export quotas the 2011 quotas will probably not be used up by weste manufacturers. This may lead China to subsequently further lower export quotas for 2012, which are bound to cause a new round of the usual China-bashing media reports.

Balance
Balance was a key word in Mr. Karayannopoulos’s presentation, and with it he means that with new non-Chinese REE projects coming on line over the next few years, a glut in one rare earth element can coexist with a screaming shortage in another. As you are probably aware, the average REE deposit is skewed towards larger volumes of what we call the light REE (LREE) whilst lesser volumes of heavy REE (HREE) are naturally produced. The relative rareness of the HREE, along with their unique characteristics, makes them largely irreplaceable, more sought after and more expensive. This makes the few deposits that contain large volumes of HREE similarly rare and valuable, and although current non-Chinese REE supply is tight across all the elements, the ramping up of the huge volumes of LREE production that Lynas and Molycorp envisage over the next few years makes Mr. Karayannopoulos very skeptical of the viability of any further projects that are focused on LREE. In fact, the less cerium and lanthanum a deposit contains and the more it contains large volumes of the elements with sustaining high demand and lasting supply constraints, the more likely the success rate of a project. Balance is the ability of a company’s production to match the elements in demand, and is crucial. Thus the inferred bottom line is that projects with a large HREE + neodymium distribution are more likely to succeed.

Next week we will get a little more technical as innovations in a number of REE-containing technologies are discussed.

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Disclaimer: The author is a researcher for the Gold&Discovery Fund, and neither he nor the Gold&Discovery Fund has commercial ties to, or shares in, the companies reviewed, unless explicitly stated in the text. The information in this bulletin is the author’s independent opinion of developments in markets and at companies, and hence may contain factual errors, and may not reflect the opinions of the Gold&Discovery Fund. The content of this bulletin is not intended as an investment recommendation.

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