Rare earths are popular, headline-grabbing metals and many expert investors are aggressively bullish on rare earths. They point to the high demand from China and the low supply of rare earths as their proof that rare earths should be in every investors' portfolio.
But Louis James, Chief Mining and Metals Investment Strategist for Casey Research, isn't bullish on the rare earth sector… at least not in the short term. He spoke at the Hard Assets Rare Earths Investment Summit (which immediately followed the San Francisco Hard Assets Investment Conference). We've summarized the main points of his presentation in this article. Where possible direct quotations have been provided.
He started by saying, "When they invited me to speak at the conference, I said: 'You realize, I'm not terribly bullish on rare earths'. But they invited me anyway to get a balanced perspective. I'm officially here to rain on your parade."
Then he put his position in perspective so that the audience would understand how he was bearish: "The demand for strategic metals will increase. They will need to be produced. But between here and [that period of high demand in the future], there is a whole lot that can happen."
Next, he gave two points about why he was bearish. "Point number one," he said. "The price environment is inherently chaotic [because] it depends on the political whim of a handful of nations, and that's not something you can count on."
Supply and demand are one of the main arguments for a bullish position on rare earth, but Mr. James revealed why he believes these arguments are not accurate: "All of the equations that people are making [to conclude that rare earths is in a bull market] are not based on supply and demand; they're not based on the inherent limitations on mining technology or the known number of deposits. They're based on a policy decision by the Chinese government."
He explained: "The Chinese can change their policy decisions at a drop of a hat. I don’t know what they are going to do next month; I don't know what they are going to do tomorrow. I don't think anybody can reasonably [know]."
"Some might say: 'Why would the Chinese shoot themselves in the foot [by making a policy decision that could reduce or eliminate the demand for rare earths]?'" And then he answered his own question: "They MIGHT do that because they're not in it for the money. [Their] priority is not profit maximization of a company – even a state-owned company. They have other priorities, and we can't know what and when they will decide." Later, he pointed out that the Chinese are such long-term thinkers that they can make decisions today that could seem to be detrimental to their cause but will ultimately help them decades in the future.
Mr. James' position is that rare earth investors are not measuring real demand but rather China's stated demand; and that could change at any time. And it's not JUST China that can change demand. Mr. James later mentioned that new technology was making current technology more efficient, but reducing the amount of rare earths in a given application.
Then Mr. James continued with his second reason why he is bearish on rare earths: "Point number two: In spite of their name, rare earths are not that rare," he said. He suggested that people hear the word "rare" and think that they should be expensive. But they aren't. "They are industrial metals. No one is going to make coins out of these metals. They are used to make magnets. They have lots of industrial applications. If we believe that there is still more economic turmoil ahead, what's going to happen to industrial metals? If we think there is going to be more economic trouble, industrial metals [may struggle]. Rare earth prices might go down just because the economy might go down."
Mr. James' second point was to show that rare earths are not like precious metals. They are sensitive to the market in the same way that other industrial metals are sensitive to the market.
So, should investors avoid rare earths completely? Mr. James has some advice for investors: "I'm not saying you shouldn't buy any [rare earths]. I'm saying be very, very careful about what you buy and why you buy it."
(Later, during some follow-up questions, one audience member asked if Mr. James was bullish on the long term. He said: "I would not be in rare earths for the long-term. Unless I had nerves of steel and had extra money that had no useful purpose, I'd place [short-term] bets on rare earths.")
Lastly, Mr. James shared some stories about companies and why they might or might not be good investments. He said: "In general, I'm not really excited about [companies that say] 'we have a great story. We have a historical resource. We're just going to come in and [drill old holes] and there's a 90% chance that we'll have the same results…’ I hate those stories. It's like playing Russian roulette with your money. Nature is not nice."
Then he told the story of a company that found some great drill results and realized they were on the edge of a great deposit. So after some analysis, they determined where the heart of the resource was and they drilled there but they found nothing. The reason was: Some mineralization event took place to degrade the heart of the deposit. That effectively shut the project down.
"If someone comes to me and tells me the NEXT drill hole is going to make them, I tell them to come see me after they've drilled the hole. Drills kill more project than they make. It's the simple math of our business," Mr. James said.
He clarified by saying that he does invest in the sector on certain occasions – specifically if there is an up-and-coming resource. "I bought into Matamec (TSX-V: MAT): Great [team]. I like their deposit. It has a lot of technical advantages and infrastructure advantages. The prospect has advantages. It's high grade. In this case, the chemistry is so complicated that being able to extract it is more important than grade. I bought them and recommended them because they were coming out with a new resource and I thought it was going to be much better than they were given credit for. And it was imminent. I wanted to get in and double my money."
He told another story (outside of the rare earths sector) of a company with a large high-grade gold deposit in Northern BC that was a 5-fold increase in their resource estimate. "When you deliver something that eye-opening to the market, you can get a substantial jump. I can see something like that happening in the rare earth market and I'd buy that."
Then he summarized his speech with some practical advice for investors: "We buy in pieces, we don't wait for an end-game, and we take the money when we can. Be cautious about what you buy and when you buy. And if you buy, be aware of the chaotic price scenario. Under the right circumstances, I would buy rare earths [with the goal of becoming] risk free as soon as I can." (He's referring to doubling his investment so that any additional profit or losses are over-and-above what he had put in).
REFERENCES
Louis James: http://www.caseyresearch.com/our-staff/louis-james
Casey Research: http://www.caseyresearch.com/
Hard Assets Rare Earths Investment Summit: http://www.hardassetsres.com/
Matamec Resources: http://www.matamec.com/