Timing & trends

Today’s Market Wrapup & Forecast

STOCKS: There wasn’t a lot of news to account for the rally on Tuesday. Some are suggesting that earnings will be better than expected. There was a release of funds to Greece and Chinese inflation was in line. 

It’s kind of hard to imagine investors saying, “Hey Chinese inflation is not too bad. Let’s buy”. I think this is all part of a rise from a very oversold condition as we’ve been pointing out for the past couple of weeks. 

GOLD:  Gold was up $12. This still doesn’t break the pattern of declining tops that has dominated the yellow metal for so long. 

CHART: I hate to keep showing essentially the same charts, but right now the message is pretty convincing and we need to remember it. There is a lot of bearishness right now. The current 20 day moving average of the CBOE put call ratio is still above the levels of the last three trading bottoms. This tells us that the rally has further to go on the upside. This message is much more important than  Chinese inflation.  

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NEWS AND FUNDAMENTALS: There were no important economic releases on Tuesday. On Wednesday we get the release of the FOMC minutes and a speech by Bernanke.   

Michael Campbell’s interview of Timer’s Digest #1 Market Timer Stephen Todd about the markets on July 6th Money Talks. Michael starts out at the 3:25 mark asking Stephen about his perspective on the overall Stock Market, followed by Gold, Silver, Currencies, Interest rates and more: 

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The Secret for Surviving the ‘Bernanke Put’

interest-rate-cutThe “Bernanke Put,” or promises of quantitative easing, has become the standard government response to economic uncertainty. But while the powers that be insist everything’s fine, Sprott Resource Corp. Founder Kevin Bambrough and COO Paul Dimitriadis see financial deterioration around the globe. Only one thing is for certain: Taking the contrarian view provides the best opportunities to buy low and sell high. In this interview with The Energy Report, they explain why they expect energy assets to perform better in the long haul, cluing us in on a few names they are considering for big returns.

The Energy Report: How would you characterize the current economic background? Are things really looking better in your view?

Kevin Bambrough: Markets typically peak when fear is low and complacency is high, and bottom when fear is rampant and people are extremely worried. The U.S. markets in general have performed quite well this year, but the U.S. bond markets have started to see a lot of hiccups. The European debt market still remains on very shaky ground. The Chinese debt market is now showing major problems in the banking system and the Japanese are still trying to find a solution to their debt woes with increased monetization, and have started an aggressive currency devaluation exercise. Debt levels for governments and individuals around the world are still at unsustainably high levels relative to GDP or individual incomes.

Bankers and governments continually lie to the public and pretend that things are better than they are. If they told the truth, no one would own a bond or keep money idle in cash. These days, the government guarantees and what people have referred to as a “Bernanke put” are the only reason rates are low and the bond market doesn’t crash. The Federal Reserve must talk tough from time to time and pretend it’s going to curtail its quantitative easing. The fact is it can’t.

Curtailing quantitative easing would force interest rates back up significantly, increase the government debt burden and raise the deficit. At the same time, it would crush the housing market and over-levered consumers already struggling to pay off their mortgages. The increased debt burden would bankrupt governments, individuals and the entire financial system.

TER: So realistically we’re stuck with low interest rates for the foreseeable future?

Paul Dimitriadis: There’s no way that rates, in my view, are going to rise anytime soon. The Federal Reserve knows it can’t allow them to rise materially. Americans may have an egocentric view that everything is fine because the S&P 500 is at a new high. Globally, the situation is not that great. The emerging markets have performed terribly this year and we’re starting to see unrest in a number of places around the world as social situations deteriorate rapidly, mainly in Brazil, Turkey, Egypt and such. All is certainly not well and I don’t expect the situation to get better anytime soon.

TER: When will everybody realize this is all a big charade?

KB: I often try to predict the catalyst that breaks the bond bubble. Government bonds are primarily held by mega funds, and sovereign banks. The banks around the world do it because they can lever up and play the carry-trade game. Most governments do it to keep their currencies low and support their export economies.

If interest rates rose, banks would be bankrupt, so they have no interest in seeding their demise. Governments try to pretend that deficits are going to eventually be brought under control, and continually make statements that there is no inflation, so they can prevent their currencies and bond markets from collapsing. Whenever economies slow as a result of higher interest rates, consumer confidence drops and interest rate-sensitive sectors like housing slow. Central bankers, or shall we say central planners, will become more aggressive with quantitative easing and bring the rates down to try to kick-start the economy again. That’s the delicate game they have to continue playing.

I expect this will continue for many years until the systemic U.S. trade deficit stops being funded by foreigners. It could be a few months from now or a few years, but eventually foreigners will come to understand the stupidity of buying U.S. government bonds to try to help their economies. I believe this is the Achilles heel of the system, and the U.S. dollar reserve-based global financial system’s days are numbered. The U.S. dollar will lose its reserve currency status when the Chinese, Japanese, Koreans and other major purchasers of U.S. bonds decide it’s not in their best interest to continue doing so. For the longest time, China and other countries have viewed purchasing U.S. bonds as an effective way to keep their currencies relatively stable. But at some point they’re going to give up on the foolishness of supporting the U.S. trade deficit and focus more on their domestic economy, rather than on competitive devaluation to support exports. The fact is, they collectively have been giving the U.S. over $500 billion worth of goods and services per year for over a decade. They will recoup little from these “loans” in the future. When they try to cash in their bond holdings, they will find there is no buyer other than the Federal Reserve, which will deliver them freshly printed currency that will only be accepted in the U.S.A. because no foreigner will want to accumulate more. When the trillions sent overseas come home to the U.S., inflation will explode and trade restrictions will rise.

TER: So how do we convert this into an investment strategy from a contrarian viewpoint?

KB: It is difficult to try to determine the best asset class to own. You also have to pick a time horizon and focus on what the world is going to look like 10–20 years from now and evaluate the asset classes that could give the best rate of return. Ultimately, we always come back to what we believe—that food, energy and other base and precious metals will do better in the long run. The key to investing in cyclical resource sectors is buying when they’re depressed. Now we’ve got a situation where they’re extremely depressed in many sectors.

TER: What are you doing at Sprott to deal with the current market environment for energy-related investments? Has your approach changed since your last interview?

KB: Precious metal equity values have come down substantially this year and we’re starting to see some very good value and opportunities in that sector. As for base metals, we still think there’s more potential downside.

We’re quite optimistic on developments in the natural gas market. Last year’s injection season marked the smallest inventory increase in the modern history of the natural gas market. The withdrawal season was also the third largest on record, and that was with relatively average winter weather. At around $4 per thousand cubic feet ($4/Mcf), demand is going to continue to grow faster than supply and that price will eventually be pushed higher. That will create value for companies like Long Run Exploration Ltd. (LRE:TSX), which we own, and which has significant natural gas exposure as well as stable profitability from its oil production.

PD: Purely gas-focused drilling activity is almost down to zero. We need to see higher prices to generate drilling demand from producers, which I think we will begin to see this year.

KB: Another sector that’s been quite depressed is coal, mostly as a result of low natural gas prices. A lot of mines have had to close or go through a restructuring. It looks like we’re getting closer to a historic bottom in coal equity valuations and so we’re looking around for opportunities to get some long-term exposure to that sector.

PD: As an example, Arch Coal Inc. (ACI:NYSE) is down from $28 to below $4 in the past two years. It was up over $70 around five years ago before the financial crisis.

KB: During a boom in any sector, a lot of the big companies are tempted to take on debt and continue acquisitions. Arch Coal still has a significant amount of debt. There are other coal companies that will certainly survive. We may not be incentivized to bring a new coal mine into production today, but there’sgreat incentive for us to buy coal mines that have long life reserves and wait.

TER: You mentioned Long Run, which we talked about during your last interview. Where do you think that one’s going?

PD: The company merged last fall (Guide Exploration Ltd. and WestFire Energy Ltd. combined to form Long Run) and recently completed its first couple of quarters as a new entity. Production is going well and cash flow is meeting expectations. It’s focusing on oil production exclusively this year due to the oil and gas pricing environment. There’s a lot of room to pay a dividend later this year or next perhaps, which both we and the market would welcome seeing. Long Run’s gas reserves are significant, so there is huge optionality on the gas side. Overall, it’s a solid story and it’s discounted to its peers, probably because it’s a new name and there’s currently a lack of fund flows into the general Canadian energy market.

Looking at the various metrics relative to its peer group, you can safely conclude that it’s trading at a 30–40% discount. If the sector gets revalued because money starts flying back into it, things can go higher from there. The optionality in the gas market could take the stock even higher.

TER: Sprott Resource Corp. completed that nice deal on its Waseca Energy Inc. holdings last year when it sold out to Twin Butte Energy after four years.

KB: We were very pleased with the performance of that company. Again, we stuck with our strategy of investing in a sector while it was depressed. We bought into heavy oil when it was no bid in Canada, formed the company and ultimately were able to monetize it when margins were significant and the company had grown from zero production into a +4,000 barrels per day company. That delivered another big win for our shareholders with a nearly $70 million profit.

PD: Along that same vein, we’ve invested in a drilling company based out of Houston, Texas called Independence Contract Drilling just over a year ago. It drills shale formations and, again, we invested in the sector when it was generally out of favor, and built the company up from book value to probably having above 12 rigs in production by the end of next year. I expect that at that time we will be able to capitalize on its strong cash flow and look for some sort of monetization, whether it’s an IPO or sale of the business.

TER: Another area we haven’t talked about yet is uranium. I know you’re into Virginia Energy Resources Inc. (VUI:TSX.V; VEGYF:OTCQX). What’s the update on that name?

KB: The uranium market is similar to coal. Natural gas has weakened valuations and demand in all energy sectors. Fukushima also really upset the short-term demand and created a very negative sentiment in the nuclear space. But demand for physical uranium for nuclear power production is going to grow over the next decade or two and mine supply will fall short with $40 per pound ($40/lb) uranium. When we look at overall planned, permitted nuclear facility growth and as well as extensions of the existing facilities, we see robust demand and we see very little supply coming on the market.

PD: We will see large supply shortfalls emerging in the next few years. The market’s going to have to catch up on funding mines, because funding has been scarce over the last few years. We believe a uranium price north of $75/lb is going to be required to balance supply. Although the Commonwealth of Virginia has not yet passed legislation that would provide a framework for permitting uranium mining projects, we are hopeful it will in the near future. At that point the company would be greatly positively revalued.

KB: Regardless of the uranium market, Virginia Energy Resources is one of the largest undeveloped uranium projects in the United States, and major producers will likely try to take out Virginia Energy Resources when the permitting framework is in place.

TER: Where you see opportunities in the fertilizer/potash markets?

PD: Potash prices have softened a bit lately. We’ve invested in one potash company that produces SOP potash, called Potash Ridge Corp. (PRK:TSX; POTRF:OTCQX). It is developing a project in Utah, we think has very favorable economics based on the preliminary economic assessment. A prefeasibility study is expected in the next couple of months, which should give greater clarity on that project. The project’s key benefits are the byproducts in the deposit, which lower the production cost dramatically. It should be one of the lowest-cost producers of SOP potash, which is a growing market globally. We’re optimistic that someone is going to have an interest in an offtake agreement and perhaps assist with the financing in the next 12–18 months.

The phosphate market has been more stable than the potash side. In the U.S., there is some risk for domestic producers due to potential shortfalls in their mines over the coming year. The phosphate market could be in very good shape over the next five years as those companies seek to replace their production. We’re quite optimistic about one of our investments in a company called Stonegate Agricom Ltd. (ST:TSX, SNRCF:OTCPK), which is developing its potash project in Idaho. That should come into production in late 2014 or 2015.

TER: Do you have any final thoughts you’d like to leave with us?

PD: The resource sector, generally, is probably the most out-of-favor it has been in a long, long time. If you’re ever going to put money to work in this sector, right around now would probably be an opportune time to do so.

KB: This is the kind of market that really allows those who are willing to step up and invest to make a lot of money.

TER: Thank you gentlemen, for your updates and insights today.

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Kevin Bambrough founded Sprott Resource Corp. in September 2007. He is a seasoned financial executive with more than a decade of investment industry experience and is a recognized leader in the commodity investing space. Since 2009, he also has served as president of Sprott Inc., one of Canada’s leading asset managers, which has more than $8 billion in assets under management. Between 2003 and 2009, he held a number of positions with Sprott Asset Management, including market strategist, a role in which he devoted a significant portion of his time to examining global economic activity, geopolitics and commodity markets in order to identify new trends and investment opportunities for Sprott Asset Management’s team of portfolio managers.

Paul Dimitriadis is Chief Operating Officer for Sprott Consulting and Sprott Resource Corp., where he evaluates and structures transactions, coordinates and conducts due diligence and is involved in the oversight of subsidiaries and managed companies. He serves on the board of directors of two of Sprott Resource Corp.’s subsidiaries, Stonegate Agricom Ltd. and Long Run Exploration Ltd. Prior to joining the Sprott group of companies, he practiced law at Blake, Cassels & Graydon LLP. Dimitriadis holds a Bachelor of Laws degree from the University of British Columbia and a Bachelor of Arts degree from Concordia University.

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DISCLOSURE: 
1) Zig Lambo conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He 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 Energy Report: Virginia Energy Resources Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Kevin Bambrough: I or my family own shares of the following companies mentioned in this interview: Sprott Resource Corp. I personally am or my family is paid by the following companies mentioned in this interview: Sprott Resource Corp. My company has a financial relationship with the following companies mentioned in this interview: Sprott Resource Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview. 
4) Paul Dimitriadis: I or my family own shares of the following companies mentioned in this interview: Sprott Resource Corp. I personally am or my family is paid by the following companies mentioned in this interview: Sprott Resource Corp. My company has a financial relationship with the following companies mentioned in this interview: Sprott Resource Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
5) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
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What the Fundamentals Say about Gold Prices!

‘Bear Raid’ with SPDR Gold Sales

After all the fall in the gold price was hard and fast due entirely to the bear raid in the U.S. This started in mid-April after the sales from the SPDR gold ETF had begun more than a month ahead of that. The signal for the bear raid was given when Goldman Sachs issued a recommendation to their clients to go ‘short’ of gold. The fall was very dramatic and shook the gold world to its roots. The volumes of physical gold that were sold were enormous. Even the Central Bank Gold Agreement limitations on gold sales (when they occurred, pre-2009) were held at 4 – 500 tonnes a year. These sales took place over three months, with the 500 tonne bear raid happening in one week.

  • COMEX warehouse reductions [200 tonnes]
  • Banks plus hedge funds sales [at over 300 tonnes]
  • Plus the heavy sales of gold from the SPDR gold ETF [at over 500 tonnes]

 

We estimate total U.S. gold sales at over 1,000 tonnes over the last four months. This saw prices fall from the upper $1,600 to $1,200 recently. This gold was bought up primarily by countries east of Greece through to China.

Reaction

It would be extremely naïve of any investor to believe that the current gold prices are now set in stone. As the low prices in the $1,200 region were reached, physical demand was very high, globally, but particularly from Asia. These have petered out as low prices have persisted, but buyers are now in the wings waiting for a ‘floor’ price to be established first.

But the fall in the gold price changed the entire dynamics of the gold market.

Before we give you these figures we will explain just how we have to distort the numbers to make them fit the impact of falling supply. To this end, we have gone against the obvious impact of lower prices and reduced demand in sectors where we know demand is bound to rise. Here’s our thinking behind the squeezing of demand into prospective supply. We do this to highlight how a tremendous price rise is needed to resuscitate newly-mined gold volumes and to distill evaporated recycled gold.

Supply

Newly-mined Gold

The falling gold price is hitting the mining equity sector extremely hard at the moment, but this will reinforce our view that the fall in the gold price is temporary.

The decision by Newcrest Mining Ltd. (NCM), Australia’s biggest producer, to write down the value of its mines by as much as A$6 billion ($5.5 billion), will lead to the biggest one-time charge in gold mining history. Rivals such as Barrick Gold Corp. (ABX), the biggest producer, and Newmont Mining Corp. (NEM) are expected to be next.

The unfortunate ‘Junior’ sector of gold mining is being savaged, with projects cancelled, mines going bust, but those able to survive for the rest of this year falling in price to levels that we believe will be absolute bargains in the months and years to come. Once the reality of the price falls feeds through to supply and demand numbers, we see share prices recovering very strongly. But today’s reality was well expressed by Nick Holland, CEO of Gold Fields, in South Africa.

He said, “There’s going to be significant rationalizing in the gold industry. You can’t keep mines producing if they’re losing money. Gold Fields South Deep mine in South Africa is one of the few mines that could survive at the current gold price of 1,230 an ounce. The mine’s size [57 million ounces of gold at 3 kilometers and deeper] and the fact that it’s largely mechanized, meaning it’s less reliant on labor demanding pay rises, will help keep costs low.” 

But he was definitive when he said that,

“Bullion must rise to $1,500 an ounce for the gold mining industry to be sustainable. The industry is not sustainable at $1,230 an ounce, which is where the gold price is at the moment [now falling through $1,200]. We’re going to need at least $1,500 an ounce to sustain this industry in any reasonable form.”

To illustrate what we mean, we note that 25% of gold mining companies are ‘underwater’ at $1,400. We expect this number to rise to over 50% at $1,200? Those who do survive will follow Newcrest and the rest of the large companies and cut their reserves and raise their grades to levels that make the mines profitable at these prices. The implication is that the supply of newly-mined gold could actually halve to 1,400 tonnes per annum? But for the sake of conservatism we only drop supply by 800 tonnes to 2,000 tonnes.

Recycled Gold

The balance of supply comes from sellers of gold, whose sales are evaporating at prices below $1,500. At 1,700 tonnes, scrap sales projected with prices around $1,650, we again underestimate the impact of $1,200 prices and give an optimistic figure of 1,000 tonnes going forward annually. This should leave total annual supply of gold at 2,400 from the projected 4,500 tonnes? But optimistically we hold it at 3,000 tonnes.

What are these? We base our figures on the World Gold Council’s estimated figures for 2013 and adjust them in the light of the above events.

Demand

Jewelry: On the demand side, for the sake of this exercise, let’s ignore the reality that jewelry demand would soar at these low prices, $1,200 or less per ounce and actually reduce jewelry demand to 1,500 tonnes, down from the projected demand at $1,650 an ounce of 1,900 tonnes. The reality is that we expect several hundred tonnes more jewelry demand at prices of $1,200 an ounce.

Technology: Let’s leave the price insensitive Technology demand unchanged at 430 tonnes.

Official sector: Likewise “official sector” demand we leave at slightly lower levels of down from our projected level of 600 tonnes at 500 tonnes.

Total bar & coin: Which has risen strongly this year to date, we reduce (wrongly) to 800 tonnes down from the projected 1300 tonnes.

Gold ETF demand: We reduce to zero down from the projected 425 tonnes.

Thus total demand for the next year unrealistically, pessimistic –allowing for ‘over-the-counter stock flows—at 3,050 tonnes. As you can see       we have to cut demandunrealistically low to match the likely fall in supply to permit gold prices to stay anywhere near today’s levels.

1

Hopefully, this is very useful to you subscribers because it paints a graphic picture of current gold market fundamentals. We’ve heard from many expert analysts, whose reputation we respect, but we see them as being very wrong-footed on their views that they see a multi-year bear market for gold. We see them as making a mistake on two areas:

1.   Demand/supply numbers will prevent this from happening as it implies a huge shrinkage in both.

2.   The price fall has been entirely a U.S. sales phenomenon, which is finite. Either the U.S. will remain out of the market going forward or will have to add to the demand figures we have described above. If they add, then gold price estimates will have to be raised significantly.

As investors, you must ask yourselves: At what price can demand be made to reduce to the levels we portray above and at what price will recycled gold supplies rise to cap the gold price and satisfy demand?

2

So when Nick Holland says prices of $1,500 are needed to sustain the gold mining industry, we think he is right. Please note that he is referring not just to cash costs per ounce produced, but cash costs, plus exploration costs, plus development costs, plus sufficient profit to distribute to shareholders to keep them investing. Cash costs at $1,200 are not the costs that make gold mining sustainable. $1,500 is far closer to the mark of real costs per ounce.

Consequently, when supplies are likely to drop to a level that even the most pessimistic demand levels are not met, we have to be close to a turn in the gold price. We attach an historic gold price chart going back to the early seventies to show the stark reality of what can happen after gold prices were held at unrealistically low levels (thanks to GoldCore.com).

Hold your gold in such a way that governments and banks can’t seize it!

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A Radical Solution for the Rare Earth Supply Crunch

JackLifton revIron miners don’t make cars, so why should rare earth miners make magnets? According to longtime rare earth expert/consultant Jack Lifton, “mine to magnet” vertical integration strategies are little more than pie-in-the-sky schemes. But Lifton just might have the perfect solution for the world’s rare earth element supply problems. In this interview with The Metals Report, Lifton tells us how a non-Chinese international rare earth toll refinery would get separated rare earths downstream more efficiently, while simplifying miners’ business plans. Find out which companies could be part of the solution.

The Metals Report: Recently, you have written about the strategies junior rare earth element (REE) miners need to follow to survive this tough market. What are the critical attributes of a surviving junior REE miner?

Jack Lifton: Junior REE miners need a well formulated business model. That is critical and often missing. My experience indicates that in the REE industry, many junior miners have not given any thought to their business beyond producing concentrated ores. In this business though, downstream processing is a critical part of the added value. A miner needs to produce something that customers want to buy. This revelation surprised many of the enormous number of juniors that popped up over the last five or six years. Companies that understood the supply chain had a greater chance of surviving. In REEs, profits are not derived directly from mining ore, because the concentrates are heavily discounted by the market due to the current shortage of accessible separation capacity outside of mainland China.

TMR: So greater vertical integration is the key to profitability? Is completely vertically integrated the best?

JL: You can’t be totally vertically integrated. The end-use products that contain REEs are complex. For example, an iron miner with the strategy to make cars would be laughed at. Yet, when a REE miner advocates making REE permanent magnets, everybody applauds. Simplistically, it sounds like a great way to make money. But it is an example of the foolish overreach by almost all of the REE juniors a few years back. And nobody has accomplished it. Interestingly, that type of “mine to magnet” vertical integration does not exist in the Chinese industry for the simple reason that it doesn’t make economic sense.

TMR: Does that mean the differentiator between the survivors and the non-survivors is technology—either proprietary technology or operational use of technology?

JL: I’m calling it “technology awareness.” In other words, company survival is dependent on recognizing limits. Patented processing technology is not necessarily important. But most companies that make REE permanent magnets have quite a bit of proprietary knowledge they don’t disclose. No outside company is going to get that process knowledge for free. When I heard about companies talking about their “mine to magnet” strategy, I realized they really didn’t understand what REE permanent magnets were all about. To me it was Bay Street hype or Wall Street hype. It was obvious promotion. However, I noticed that small investors and even institutional investors, who should know better, were falling for this story.

I have been saying from day one—total vertical integration is not possible. Now that doesn’t mean that there weren’t companies like Great Western Minerals Group Ltd. (GWG:TSX.V; GWMGF:OTCQX) or evenMolycorp Inc. (MCP:NYSE), that weren’t attempting to do this by mergers and acquisitions. Great Western, for example, acquired what was an existing high-technology company, Less Common Metals Ltd. of Great Britain, which was already in the rare earth magnet alloy market making a profit. What Great Western did with Less Common Metals was an example of sensible vertical integration. However, when companies started trying to get into these technology-enabled end products on their own, this was just silly.

Companies should have been looking at each step of the process required to produce a sellable product. They needed to understand a multi-step value chain. For example, if they are able to concentrate the REE ores, what do they do with the ore concentrate? How will the company get from the ore concentrate to some kind of chemical solution or solid form that it can then further process? With the REEs, the first step to create a bulk concentrate is not much of an accomplishment. The real problem in REE processing is separation—and that is the issue that most REE juniors have not solved in a cost effective way.

TMR: Are there technologies that differentiate some juniors in separation?

JL: No. At this point, everyone is planning to separate and purify REEs using the same basic technology, called solvent extraction. The differentiator is the ability to cost effectively separate the most valuable heavy rare earths (HREEs). The richest REE mineral concentrate contains little of the desirable HREEs. Most REE ore is 75% to 80% light rare earths (LREEs)—mostly lanthanum, cerium, neodymium and praseodymium. Of the LREEs, the only one that is really critical is neodymium, which is the basis of most of the REE permanent magnets. All of the other critical REEs, the ones that we really need in our modern technology are the HREE category. Altogether, these would not exceed more than 15–20% of the total mass of the best ore. When processing and separating REEs, almost 80% of the material will be lanthanum and cerium with a smaller amount of neodymium,the revenue from which has to pay for the separation of all of the first three elements. After that, the operator needs to calculate if it makes sense to keep running to produce another 5–6% of the HREEs that are valuable. While the richest deposit is up to 20% HREEs, an average deposit is more likely between 1–5% HREEs. As ore is processed to separate the less common HREEs, the cost gets progressively higher. Solvent extraction is a very expensive process such that operational costs of the technology becomes a differentiator. When it comes to survivors, we can discuss a company like Orbite Aluminae Inc. (ORT:TSX; EORBF:OTXQX). Orbite’s success isn’t all about a new technology, it’s about a streamlined technology.

TMR: What is Orbite doing differently than others?

JL: Orbite is starting small. The juniors that I believe will survive have a willingness to cut back on their projections of future production volume. I’m only going to talk about those who are not yet producing. In the United States, for example, there is Ucore Rare Metals Inc. (UCU:TSX.V; UURAF:OTCQX) and Rare Element Resources Ltd. (RES:TSX; REE:NYSE.MKT). In Europe we’re talking about Tasman Metals Ltd. (TSM:TSX.V; TAS:NYSE.MKT; TASXF:OTCPK; T61:FSE). These companies have all developed the same business model independently. The idea is to size mining and refining correctly. The total output of Ucore will be 2,200 tons per year (2,200 tpa) total rare earth oxide (TREO). Rare Element Resources and Tasman are on the order of 5,000 tpa each of TREO, which are skewed in total value toward the HREEs.

A good example of right sizing is Rare Element Resources recent business model showing the majority of its income will come from everything but lanthanum and cerium. Lanthanum and cerium in that plan are around 15% of the total value. To me, this is excellent. Those elements are nearly 80% of the produced volume, but represent only 15% of the revenue. The majority of the revenue comes from neodymium and heavier elements. The plans for Ucore and Tasman are similar. They have refocused their business models to produce less volume and more of the “good stuff.” To do that they had to reconsider their plans for building solvent extraction plants. The new plans are not like Lynas Corp. (LYC:ASX) or Molycorp. The Lynas plant will process 122,000 tpa of ore, to produce 22,000 tpa of concentrate mostly in lanthanum, cerium, neodymium and praseodymium. Approximately 5% of the total is the midrange and HREEs. That is only 1,000 tpa of the best material. But the company has had to construct one of the largest solvent extraction plants in the world to be able to get at that 1,000 tpa.

The current production rate at Molycorp is approximately 19,800 tpa. It is almost entirely LREEs, because the deposits in California do not have significant midrange or HREEs. Unless they bring in new ore sources, they will be producing exclusively LREEs. The publically available numbers indicate the Molycorp plant cost over $1 billion ($1B) and Lynas approximately $800 million ($800M). Those are huge capex numbers for an industry that is under price pressure.

The business models of Rare Element Resource, Ucore and Tasman call for separation plants of 2,200–5,000 tpa. Frontier Rare Earths Ltd. (FRO:TSX) in Africa is approximately the same size. Assuming that costs scale, to estimate the capex of a 5,000 tpa plant, I can divide Lynas’ approximate costs by four. That is about $200M for a plant to produce 5,000 tpa. Ucore’s projected costs are lower according to its plan. These capex figures are numbers that are reasonable if you’re producing HREEs.

Let’s discuss Orbite again, where the situation is a little different. The company’s plan is to establish a 1,200 tpa solvent extraction REE separation plant. It is designed to process the entire spectrum of REEs. Orbite’s REE capex plans amount to $32M based on using byproduct feedstock from a large aluminum oxide plant to be brought into operation on the Gaspé Peninsula of Québec. A 1,200 tpa, total-spectrum REE plant for $32M is much cheaper per-unit capex than either Lynas or Molycorp, both of which have plants that are limited LREE separation. If the Orbite facility can be built according to plan, it will be a benchmark for low-cost REE separation. Keep in mind that Orbite is not a REE company. Orbite is a high-purity alumina oxide company that plans on producing REEs as a byproduct.

I’m very impressed by what I know of Alkane Resources Ltd.’s (ANLKY:OTCQX; ALK:ASX) business model. Alkane is a polymetallic producer and its mix of metals, which includes zirconium, niobium, yttrium, REEs and gold, has allowed it to minimize the risk of depending entirely on REE production. Alkane is making a series of individual off-take agreements with separate vertically integrated refiners who themselves are also downstream end users and marketing experts in the products for which Alkane will provide the feedstock. This is an outstanding 21st-century business model that has allowed Alkane to create a synergistic revenue stream. In a sense, Alkane has become a mini-Glencore International Plc (GLEN:LSE), a vertically integrated trading company. This is a business model that I urge juniors with polymetallic deposits to emulate.

These producers are all pushing the industry toward centralized HREE separation. It would make a lot of sense if individual producers focused on LREE separation and left the heavy concentrates to be toll processed centrally by one company. HREE separation is a capability today of the Rhodia division ofSolvay Group (SOLB:NYX), which has a full-scale separation plant of 9,000 tpa in France that processes the total spectrum of REEs. That plant has been in operation for 45-years and is dedicated to making specialty chemicals for the Solvay Corporation, the current owner of Rhodia. The Rhodia feedstock is mostly sourced from China and production is geared toward internal company needs—at this time it is not a toll separation plant.

TMR: Is there room in the industry for an international toll separation plant to be built?

JL: Yes. Even if Rhodia were to run its current plant only as a toll separation, it wouldn’t produce enough volume both for Rhodia’s internal needs and for the international, non-Chinese consumers.

TMR: In August, you are presenting your case for a new international REE toll refinery to the Chinese Society of Rare Earths. What reaction are you expecting?

JL: My thinking about this has evolved. I think that the Chinese want this to happen. The Chinese are now restructuring their REE production industry and downsizing it to match their internal demand. They will grow the industry in the future, but only to meet their domestic demand. I do not believe that the Chinese are interested in the REE export business. In the last year the Chinese have cut legal, reported production by more than 30%. Originally, Chinese domestic users consumed 60% of their own production. It’s up to more than 80% today. When I proposed an international toll refinery, I was surprised at the positive reaction I got from this in China. I was told by a high-ranking Chinese official in the REE industry that this is an excellent topic. The Chinese really do want to hear outsider views on this. It appears that the Chinese would like the rest of the world to develop enough REE production and refining so that the domestic Chinese REE industry can be left alone. That’s my analysis at this point in time.

TMR: How would new international toll refining change REE pricing? Would there still be a Chinese domestic price and a different international price?

JL: Yes. At the moment the export prices are set by tax. Domestically, Chinese REEs are much cheaper than internationally posted prices because of the large export tax. There’s a cap on volume as well as a large tax. The prices we see for cerium or lanthanum in North America, for example, are Chinese domestic prices plus export duties and transport.

The problem for a new REE producer is—which price is it that you’re going after? For example, say I can buy lanthanum in Chicago for the Chinese export price of $20/kg. Suppose I can produce lanthanum in New Jersey for $10/kg. That looks like a solid profit. The problem is “where is your market?” Yes, $10/kg is great if you’re going to sell this into a North American market and the Chinese maintain their export duties. That is fine, except that there’s no real market for these materials in North America. There’s no total supply chain outside of China. China is the main place where the raw materials get turned into finished product. China is the only location of an existing “mine to magnet” total supply chain. Better than even, “mine to magnet,” China has “mine to vacuum cleaner,” “mine to car,” and “mine to washing machine.” They’ve got everything. As a North American producer of lanthanum, I’m going to have to sell into China at the domestic price, and pay the import duty and cover transport costs. These are all issues that junior miners do not think about. But these issues matter if you are trying to finance a $1B refinery. Is there a market at the price you’re going to produce? It’s not just about your costs per kilogram. When there is an accidental or intentional monopoly player like China, there are substantial additional factors to consider. And we haven’t even mentioned the possibility of import quotas. And then there is the uncertainty. . .everything could change tomorrow.

The Chinese REE market is evolving rapidly. They have dramatic overcapacity in everything: mining, refining, fabrication, you name it. There is a desire to cut back to profitable unit production. As they move in that direction, prices will rise in China. The Chinese goal is to have prices that can sustain the industry. External competition in the commodity markets is not their concern. The model of Rhodia as a toll refinery does not concern China. Solvay is not in the mining business. They don’t make metals. They don’t make magnets. They are a solvent exchange separation and high-purity refining company. Their output goes directly to the chemical, automotive and high-tech industries. Rhodia has a large competitive advantage because of its extant investment and China is not trying to take it away.

However, REE permanent magnets are a different business because the refined elements from a company like Rhodia have to go to metal maker, an alloy maker and then a magnet maker. While they have these industries in Europe, there is not enough capacity to satisfy all European industrial demand. The Chinese dominate the HREEs because there are no sources outside China. There are still no mines outside of China that are producing significant quantities of HREEs. The Chinese still supply 100% of the world production.

The locations of the REE survivors will determine where the toll refining business opportunities will happen. Ucore is in Alaska, Rare Element Resources in Wyoming. The American political climate is such that exporting natural resources to China, especially ones that have been as hyped as REEs, is not very likely to get the support of the government. Therefore, I think there is a strong possibility of a REE toll refinery being built in North America.

Tasman is located in Sweden and does not have to deal with the U.S. political climate. In this case, there is a strong possibility that HREE concentrates will be sold to China, for processing inside China. Other than Rhodia and perhaps two other small facilities in Japan, there’s no HREE processing capability outside of China. While Tasman could ship ore or concentrates to China for the dysprosium content, the company wouldn’t make any money doing it. Tasman is under review by several European companies as a source for potential feedstock into their vertical supply chain. That would be one path to the creation of a central European REE toll separation and refining plant.

The entire HREE industry of the world, which today is 100% in China, produces total of 15,000 tpa of HREEs. Of that, 60% is the element yttrium. Two new toll refining plants outside of China could double the world’s production of the HREEs. In order to do that, we’d have to obtain HREEs ores from outside of China. The surviving juniors will be the companies that supply the midrange and HREEs to these types of refineries.

TMR: Could the Molycorp plant be modified slightly become a toll refinery?

JL: It would be more than a slight modification. It would be very expensive. I wrote earlier this year that if I were Molycorp, I would change the company direction. I would deemphasize mining and expand the Phoenix project to be the Western world’s toll refiner. To me, that would be an ideal solution.

TMR: Does Molycorp agree with you?

JL: Well, I have to admit that statement of mine met with some ridicule from the company, but now I’ve noticed that they’ve gotten very quiet. The company is in the process of restructuring. Theoretically, as a toll refinery, Molycorp would be well positioned. Executing that strategy would be another matter. Financially, it would be tough. However, although the California plant only separates LREEs, Molycorp is in that business of total-spectrum rare earth separation because of its ownership of Neo Materials, which has two small plants in China. Those are relatively small plants, but they are capable of processing and purifying HREEs. Putting that technology into operation in California would be expensive. However, I think that’s a good idea. Because Molycorp has no HREE feedstock, it would become a toll refinery.

TMR: Is there anything you want to summarize before we sign off?

JL: The “good stuff” the industry needs is the HREEs. I still hear to this day, “Rare earths are like gold.” No they’re not. Not all of them. The juniors that have worked out solid business models to produce HREEs will be the survivors. One or two international toll refineries would further enable the development of any and all of these deposits. If there was a toll refinery that could process midrange and HREEs concentrates, this would make ventures in Australia, like Hastings Rare Metals Ltd. (HAS:ASX) andNorthern Minerals Ltd. (NTU:ASX), extremely interesting while simplifying the business models for the junior miners we discussed. Otherwise, we’re going to wind up with a monopolized Chinese REE industry and the rest of us will be looking at it from the sidelines.

TMR: It has been great to talk to you again.

JL: Glad to speak with you.

Jack Lifton is an independent consultant and commentator, focusing on market fundamentals and future end-use trends of the rare metals. He specializes in sourcing nonferrous strategic metals and due diligence studies of businesses in that space. He has more than 50 years of experience in the global OEM automotive, heavy equipment, electrical and electronic, mining, smelting and refining industries.

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DISCLOSURE:
1) J. Alec Gimurtu conducted this interview for The Metals Report and provides services to The Metals Report as an independent contractor. He 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 Metals Report: Great Western Minerals Group Ltd., Orbite Aluminae Inc. and Tasman Metals Ltd. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Jack Lifton: I or my family own shares of the following companies mentioned in this interview: None I personally, as an operations consultant, am paid by the following companies mentioned in this interview: Ucore Rare Metals Inc., Rare Element Resources Ltd. and Tasman Metals Ltd. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview. 
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With almost half of Canadian farmers aged 55 and over, a burgeoning number looking to build a retirement fund from the sale of their land have access to a new class of buyer – venture capitalists.
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