Strategy Metals Bulletin (52)


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Terrence van der Hout , of Gold & Discovery Fund provides his thoughts on the 7th Hong Kong Rare Earth Conference.

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Strategy Metals Bulletin (52)

  1. 1. (52)T c v d Ho Nov 13 - 19, 2011Gold&Discovery FundAims to update investors on developments in the world of strategy metals – crucial inputs to industry, defense and technology innovationThe 7th Hong Kong Rare Earth Conference was a packed affair, and a changed presentationline-up and attendance crowd underlined the road to adulthood the REE industry iscurrently undergoing. Presentors now came from various industry end-users, researchand innovation labs, and China, as opposed to the usual western gurus and juniorhopefuls 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 moredetailed and granular. I will review a number of interesting speeches over the next fewbulletins. This week I will focus on the opening presentation by ConstantineKarayannopoulos, CEO of Neo Material Technologies (NEM.T).Neo Material TechnologiesNeo Material is a major processor of rare earth materials, producing 85% of the Chinesemarket for the all-important magnetic powders. These powders are used to make highperformance magnets which in turn are input to all hard discs, mobile phones,automobiles and various green tech innovations such as wind turbines etc. The rare earthindustry is said to be driven primarily by magnets. Neo Material Technologies (as well asits European counterpart Rhodia) is therefore at the heart of the rare earth industry, andcomments from the company are generally worth listening to. Mr. Karayannopoulos wenton a myth-busting tour and made a number of interesting comments on developments inthe markets.Myth number 1Myth number one is the generally accepted truth that China’s low cost production in rareearths that drove out international competitors at the beginning of the millennium wasdue primarily to its dismal environmental regulation and low labour costs. In fact, China’senvironmental regulations are stricter than almost anywhere else in the world, and thestandards themselves are not an issue. It is in the enforcement that things are goingwrong in China, and this makes me wonder if the increased recent regulation in terms ofinvoice systems, production quotas, attempts at price controls, centralization, and fiveyear investment and innovation targets that are sending shivers down the spines of freemarket adherents are going to be effective if the same level of commitment is not givento enforcement. There are no free markets in rare earths, as readers probably know bynow, and I guess rigid and expensive enforcement is a necessary burden on those seekingto monopolize. 1Terence van der Hout Strategy Metals Bulletin; Nov 13 - 19, 2011If you wish to receive this bulletin, please email me at:
  2. 2. Mr. Karayannopoulos believes that it is particularly the fiercely competitive nature of thenumerous internal domestic REE operations that has lowered costs in China over theyears. Also, given the by-product nature of rare earths at Bayan Obo (the largest rareearth mine in the world is primarily an iron mine), production of rare earths is virtuallyfree because capital expenditures and operational expenditures are borne by the ironproduction. How do you compete with that. A third reason for the low costs is in therandomness of geology, which has dictated that the rare earths in China are easilyextractable and separable, implying low processing costs. Finally, innovations in the fieldof chemistry has given an advantage. In China, operators were able to successfullytransfer from the use of nitric acid to the much cheaper hydrochloric acid as a means ofextracting the elements from their minerals.Myth number 2Myth number two that was presented by Mr. Karayannopoulos, concerns the widelyaccepted idea that rare earths are irreplaceable in their various applications. Because oftheir 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 alogical consequence of input prices rising from say $3 per kg to $125 per kg over a twoyear 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 haveacceptable 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 inupcoming articles, as to me this presents the core of where rare earth markets areheaded for the coming years.Mr. Karayannopoulos then turned his attention to innovations focusing on efficiencies interms of volume-reduction of the now high priced rare earths. Shin-Etsu, a large Japanesemagnet producer, has focused on significantly reducing the input of dysprosium in theirnewest NdFeB sintered magnets, and have been able to engineer the hugely expensiveterbium completely out of the magnet, apparently at no loss to performance. Rather thanbeing a threat to the demand for rare earths, I view these kind of developments as a verynatural part of innovation cycles, and is a driver of efficiencies. This is not reducing theneed for rare earths, but rather structural shifts in the supply and demand parameters perseparate element.Market developments: lagging demandAccording to Mr. Karayannopoulos, weakness will prevail in the non-Chinese demand forrare earths in the short to medium term. Japan’s Fukushima disaster has impacted allindustrial production and therefore demand for these inputs. Japan, needless to say,constitutes a large part of demand for processed REE in concentrates, powders and alloysfor their automotive and high-tech industries. Adding further to the depressed REEmarkets are the recent floods in Thailand, where most of Neo Material’s non-Chineseclients are situated. Hence, Mr. Karayannopoulos sees the FOB prices of dysprosium,cerium and lanthanum dropping further over the next couple of quarters. 2Terence van der Hout Strategy Metals Bulletin; Nov 13 - 19, 2011If you wish to receive this bulletin, please email me at:
  3. 3. Market developments: lower ROW demand will drive 2012 export quotas lowerMr. Karayannopoulos estimates that total demand outside of China (ROW) amounts toroughly 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 thefact that demand has slumped significantly, Mr. Karayannopoulos believes that despitethe recent global outcry over diminishing Chinese export quotas the 2011 quotas willprobably not be used up by western manufacturers. This may lead China to subsequentlyfurther lower export quotas for 2012, which are bound to cause a new round of the usualChina-bashing media reports.BalanceBalance was a key word in Mr. Karayannopoulos’s presentation, and with it he means thatwith new non-Chinese REE projects coming on line over the next few years, a glut in onerare earth element can coexist with a screaming shortage in another. As you are probablyaware, the average REE deposit is skewed towards larger volumes of what we call the lightREE (LREE) whilst lesser volumes of heavy REE (HREE) are naturally produced. The relativerareness of the HREE, along with their unique characteristics, makes them largelyirreplaceable, more sought after and more expensive. This makes the few deposits thatcontain 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 ofLREE 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 onLREE. In fact, the less cerium and lanthanum a deposit contains and the more it containslarge volumes of the elements with sustaining high demand and lasting supplyconstraints, the more likely the success rate of a project. Balance is the ability of acompany’s production to match the elements in demand, and is crucial. Thus the inferredbottom line is that projects with a large HREE + neodymium distribution are more likely tosucceed.Next week we will get a little more technical as innovations in a number of REE-containingtechnologies are discussed.Twitter: @GoldDiscFundwww.gdfund.comDisclaimer: The author is a researcher for the Gold&Discovery Fund, and neither he nor the Gold&Discovery Fund hascommercial ties to, or shares in, the companies reviewed, unless explicitly stated in the text. The information in this bulletinis 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 investmentrecommendation.Copyright: The information in this bulletin can be forwarded, cited or used otherwise, but only within the context asintended by the author, and with complete reference to the source. 3Terence van der Hout Strategy Metals Bulletin; Nov 13 - 19, 2011If you wish to receive this bulletin, please email me at: