Going with Your Gut on Rare Earth Stocks: Mike Niehuser
Tue, Oct 23, 2012
Mike Niehuser isn’t a rare earth expert per se, but the Beacon Rock Research founder says many of the same investment principles hold true for resource stocks across sectors. At the end of the day, all resource stocks, rare earth plays included, are story stocks, and it takes intuition to buy or sell successfully. In this exclusive interview with The Critical Metals Report, Niehuser tells the spellbinding stories of two promising rare earth companies.
Going with Your Gut on Rare Earth Stocks: Mike Niehuser
The Critical Metals Report: You have given several interviews on The Gold Report, but what makes you an expert in rare earth elements (REEs)?
Mike Niehuser: I don’t consider myself to be an expert in anything. I’m a generalist. REEs are complicated in most every way. But the very same investment principles hold for REE companies as for other mining, resource or small-cap company. As an investor, I am more intuitive than data driven. Mining and resource stocks are all story stocks. You can make some relative data comparisons, but each data point requires some subjective judgment on the substance of the company and the nature of the competitive environment. Small-cap companies are by definition the least understood and therefore hold the greatest opportunity for above-average returns. In the case of mining stocks, you can never know it all, and I enjoy being frustrated. I’m curious by nature, and I love learning. I think success depends on applying a craftsman-like attitude of study.
TCMR: What do you look for in REE companies?
MN: Management is the beginning and the end for investing in small-cap companies. I look for companies with teams that have hung together through the good and bad times. If they have, this is an indication that they see something that works in their team and have tested their mettle in adversity. In addition, I look for some sense of accomplishment on a bedrock of humility, where unexpected results fuel their curiosity and power through piles of data. In the case of REE companies, the sector is redeveloping and old assumptions and new techniques all need to be questioned.
TCMR: So management is first. What’s next?
MN: I don’t want to sound like a broken record, but with REE companies or any mining company, political jurisdiction is becoming increasingly apparent as the differentiator. I suppose it is natural for governments to see higher metal prices as an opportunity to rewrite laws to take a greater share. If nothing else, I don’t feel as safe traveling as I did just a few years ago. If I don’t, neither will others, and I know capital won’t either. I think these governments will find out that they can’t develop resources economically without collaborating with others, and this includes foreigners. This will mean they will need to use permitting to select the right partners. This is where management comes in: They can create greater value for shareholders and the nations in which they operate. There are less attractive partners, ones which perhaps nations feel better dealing with, but the results don’t trickle down to the people.
TCMR: Who are you referring to?
MN: National companies subsidized with government support may be tempting for countries willing to bend the rules. Small companies cannot compete here except on quality. Mining is a long-term business; if successful over decades, the real winners will be both small-cap companies that operate in political jurisdictions and the governments that have the best interests of their people at heart. In general, shareholders of publicly traded mining companies have an increased expectation for integrity and fair play. They know that cutting corners for short-term gains will be met with dramatic unexpected losses over the long term.
TCMR: What makes REE companies attractive today?
MN: The mining industry has been beat up in a risk-off investment climate, despite near-record precious and base metal prices. Unlike precious metals, REE prices are well off record highs, taking the miners in this sector down even further. In general, most of the money is made in the market by select investing at market bottoms, so we see an opportunity for careful stock picking. I do have a couple of opportunities to share with you, but let’s get through the fundamentals first.
TCMR: So in addition to management and country risk, what is important when screening the REE companies?
MN: Rare earth projects are complicated, as they are always composed of a basket of REEs that have discrete supply and demand characteristics with varying opportunities for recovery. The best snapshot for even the novice investor is Technology Metals Research’s TMR Advanced Rare-Earth Projects Index. This chart shows the universe of companies with compliant resources by grade and, most importantly, the potential basket price based on the composition of metals. This is only a two-dimensional snapshot, as it does not take into account the size of the project, which is important for achieving critical mass to support what could be an extensive capital investment. It is interesting that the chart demonstrates that heavy rare earth (HREE) deposits appear diametrically opposed to deposits with high grades of light rare earths (LREEs). Investors should be aware that the market for REEs is much smaller than the one for copper or lead and that the REE markets for specialty industrial uses is much smaller. In any event, TMR provides an excellent chart on their website that is free to view, and articles with a helpful blog in which they provide timely public responses.
TCMR: Why should investors care if companies have more LREEs or HREEs?
MN: HREE prices have held up better than those of LREEs in the recent downturn. Some LREEs are in perceived oversupply, and with additional production from new mines, including Molycorp Inc.’s (MCP:NYSE) Mountain Pass or possibly Lynas Corp.’s (LYC:ASX) Mount Weld, the prices of some of these LREEs may never recover. On the other hand, all REE companies appear to have been taken lower by the market indiscriminately, along with most junior resource stocks. We believe that trends toward shortages in some REEs, particularly HREEs, will continue to stand out.
TCMR: Why are HREEs so important?
MN: The U.S. Department of Energy lists neodymium, an LREE, and four HREEs including dysprosium, europium, terbium and yttrium as the five elements of highest importance for clean technology and at greatest risk for supply in the next five to fifteen years. Dysprosium is clearly recognized as the most critical REE, having both high importance for clean tech and high supply risk through 2025. Terbium is also expected to have a high level of supply risk through 2025. The U.S. Department of Defense recognizes a strategic deficit in yttrium, which is critical to several advanced weapon systems such as stealth helicopters and precision-guided weapons, as well as dysprosium and terbium for permanent magnets.
TCMR: Why should investors consider REE companies?
MN: Some experts are starting to declare a bottom in HREE prices. While this is not certain, the trends toward a supply-demand imbalance for HREEs appear very probable. The only thing that would take it off course would be overwhelming new supply, a tanking global economy or a reversal in trends toward innovation in sectors that are currently firmly dependent on REEs. What is more than certain is that many of these REE companies, even those with heavies, are trading near cash on the books, which suggests that both light and heavy REE projects are getting no value in the market. Most projects will not survive; in fact, the survivors might be counted on one hand. But I would agree that signs are showing that we may be passing the bottom.
Keep in mind that China has dominated the REE supply chain for decades. As a nation, it has relied on its competitive advantage for low-cost mineral production as a pillar of economic policy. Although it is the major producer, it has recognized that it does not have a sustainable source of HREEs; it could potentially run out in five to fifteen years, and may become a net importer, particularly for dysprosium. China is also attempting to develop a balanced domestic economy by manufacturing value-added goods and regulating domestic mining of REEs, particularly HREEs, which are cheaply mined from ionic clays, but cause environmental damage to rivers.
TCMR: What differences do you notice most in evaluating REE companies?
MN: As we discussed, management and political jurisdiction are the first differentiators on the list. But on a project level, the composition of metals is important. Capital will pursue projects with the best distribution of heavies, grade, volume, political jurisdiction and management. I think companies with the optimal mix will move higher.
TCMR: Who should investors take a closer look at?
MN: I have a bias toward small companies that are not well known. Those with the best chance of being discovered sooner rather than later have the greatest near-term upside potential. There are a lot of fine companies out there. For example, Molycorp should be applauded for becoming the first producer of REEs in the current metal cycle, but it is well past discovery. There are three or four other names also past discovery, but the latest developments suggest a less-than-competitive mix of investment characteristics. I am looking for companies with surprise potential, like with any small-cap investment. Today I would suggest two companies, which oddly enough are both headquartered in Nova Scotia, one four time zones to the west of its project in Africa, and one four hours east with a project in Alaska. I think both companies have accomplished management and have projects in promising political jurisdictions.
TCMR: Which company presents the best value today?
MN: Namibia Rare Earths Inc. (NRE:TSX) is trading just above cash value and is, in my view, the newest and deepest-value REE company. The company just published its initial HREE resource at its Lofdal project in Namibia, which is exceptional in that it has the highest total rare earth oxide (TREO) basket price of any of the 44 companies presented on the TMR chart. The exploration team has completed a very tight drill program and they have potential to upgrade the classification of the resource by successfully completing the metallurgical program now underway. They might move Indicated and Inferred resources into the Measured and Indicated without additional drilling. They have also built the resource from surface to 75 or 150 vertical meters. As some of the best results have been at 175 meters and to 250 meters, the expansion potential is real. They are waiting on assays to a depth of 350 vertical meters.
TCMR: How does Namibia rate as a mining jurisdiction?
MN: I think Namibia is one of the only countries in Africa I would feel comfortable taking my family. Namibia is a former German colony that was occupied by South Africa until gaining its independence in 1990. It is a young country, but being a former German colony, it has exceptional infrastructure, including power and roads. It is a big country, slightly larger than Texas, but with only about 2 million people. Environmental tourism is one of its major industries. In terms of being a stable mining jurisdiction, Namibia is one of the world’s leading uranium producers and mining is a major industry. Their mining laws are well tested and evolving; the government there appears to have more interest in creating wealth than settling old scores.
TCMR: How else does the company stack up?
MN: Namibia Rare Earths’ management team ran Etruscan Resources in West Africa. They had great exploration success working in five countries and building the largest land position of any junior resource company. This led to the development of operating mines in Niger and Burkina Faso and advanced projects in Cote d’Ivoire and Mali. They were instrumental in helping these countries develop and attract capital. They discovered REEs at their Lofdal project in Namibia while it was an asset of Etruscan before being spun out. The current resource at Lofdal is the first one on its 200-square-kilometer project, and management thinks there’s high potential to find more. They think the geology at Lofdal is like a treasure chest. Management has focused on resource development and building a credible resource with great potential for expansion, as opposed to rushing Lofdal to a PEA or to complete off-take agreements. Consequently, having achieved the highest basket price among other REE companies, it certainly is going to get a close look.
TCMR: What type of REEs does Namibia Rare Earths have at Lofdal?
MN: Namibia Rare Earths has an Indicated resource estimate of 900,000 tons of 0.62% TREO, of which 86% is enriched by HREEs. There is an additional Inferred resource of 750,000 tons at 0.54% TREO with 85% HREE enrichment. The four highest metal types by value include dysprosium, terbium, europium and yttrium, and only about 2% by value being the LREEs lanthanum and cerium. This is an exceptional HREE resource. If the metallurgical report provides for the upgrade of classification to Measured and Indicated, it may also provide for a lower cut-off grade and we could be talking a 6 million ton (Mt) resource. This would be at a lower grade, but there are indications from sorting tests that they could upgrade the resource to 1% TREO, which could triple the value of the feed to a mill. Investors interested in Namibia Rare Earths should keep an eye open for deeper drill results that would confirm the potential to expand the existing resource even further as well as the results of the metallurgical study.
TCMR: Who is the other Nova Scotia company you wanted to mention?
MN: Ucore Rare Metals Inc. (UCU:TSX.V; UURAF:OTCQX) has a HREE project in southeast Alaska. The Bokan Mountain project is located near Ketchikan, Alaska. The company is rapidly advancing the project and has recently completed several “firsts,” which investors may not have taken into account. It recently announced successful separation of HREEs including dysprosium, neodymium and erbium, producing a purified salable product. In addition, this process nearly removes all of the undesirable elements including iron, uranium and thorium, which may be returned to the mine in paste backfill together with all of the mine tailings. This means Ucore’s Bokan operation will have minimal daylight expression at surface and a very small environmental footprint.
TCMR: The paste backfill must have pretty good appeal for government regulators.
MN: That is certainly correct, but Ucore has impressed several layers of government in Alaska, and the U.S. The U.S. Department of Defense has recognized the importance of the project in securing a sustainable North American resource of HREEs. It has also received support from its congressional representative to advance road access and other infrastructure developments in national lands. The state of Alaska also sees the potential for drawing value-added businesses to Alaska, like permanent magnet manufacturers. Support includes ongoing financial support for metallurgical study at the University of Alaska Fairbanks, and support for developing cheaper hydropower alternatives near the mine. The company is currently reviewing the latest solid-phase extraction that removes deleterious elements, purifying the concentrate on a molecular level.
TCMR: How does Ucore’s resource at Bokan Mountain stand up?
MN: Bokan Mountain has an Inferred resource of about 5.3 Mt of 0.65% TREO, of which 40% is enriched by HREEs. This is a modest initial resource estimate. The project is open to expansion, and it has excellent potential for value enhancement with the new solid-phase extraction process. The positive results of the study have led the company to delay completion of the PEA, but it has good potential for accelerating in improving the confidence in the bankable feasibility study. Upon completion of the PEA, Ucore will also be able to actively pursue off-take partners. From our vantage point, we see its partnership with the Department of Defense as providing substantial long-term support, mitigating political risk.
TCMR: When will interest increase in REE companies like Namibia Rare Earths and Ucore?
MN: I think the market is always looking for a bottom and is ready to start accumulating companies that look like winners. Ucore’s recent price movement supports this idea. The market is looking for companies with the ability to jump the metallurgical hurdle. This is why Namibia Rare Earths, while less advanced than Ucore, still presents a deep-value exploration opportunity.
TCMR:Thank you, Mike.
MN: My pleasure.
Mike Niehuser is the founder of Beacon Rock Research LLC, which produces research for an institutional audience and focuses in part on precious, base and industrial metals, oil and gas and alternative energy. Previously a vice president and senior equity analyst with the Robins Group, he also worked as an equity analyst with The RedChip Review. He holds a bachelor’s degree in finance from the University of Oregon.
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1) The following companies mentioned in this article are sponsors of The Critical Metals Report: Namibia Rare Earths Inc. and Ucore Rare Metals Inc. Interviews are edited for clarity.
2) Mike Niehuser: I personally and/or my family own shares of the following companies mentioned in this interview: Namibia Rare Earths Inc. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
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