Rare earth shares still attractive: LYC shares leading

Rare earths have become the hottest commodities on the planet over the last few months.We’ve seen heaps of coverage about the sector, with the media, in particular, covering Lynas shares in detail.

For people looking to invest in shares, seeing rare earths in the business pages has been confusing. What are they and why are they getting so much converge?

Unsurprisingly, the answers to both of these questions are related.

First, rare earths are the key unique minerals that are used to drive a whole variety of high-tech inventions. And because of this, there’s a global power play being acted out over the importance of maintaining supply.

For the last two decades, the majority of rare earths were being shifted from China. That’s not because China has all the deposits; they do, to an extent, but that’s not why rare earth production dried up in the Western world.

No, the reason China dominates production is because of the same reason China dominates everything, nowadays: low production costs.

Too little, too late

The western world, with deposits in the US, Canada, South Africa and Australia, gave up on production once Chinese producers entered the market in the early 1990s. Not only were Chinese producers cheaper, but also they have less onerous environmental regulations to deal with.

However, over the last year or so, China has become increasingly concerned with ensuring supply to Chinese manufacturers.

This caused China to cut export quotas in July of this year, reducing exports by 40%. Rare earth prices have jumped to around $3000 per tonne from $1275 a tonne in 2008.

The major uses of rare earths include catalytic applications due to their ability to store and release oxygen, such as in cars, optical applications thanks to their high refractive index and fluorescence, for use in mobiles phones and computers, and electrical applications thanks to their high conductivity.

Back in the game?

Over the past couple of years, however, the western world has started to develop rare earth operations as buyers start to fret about Chinese control of the industry.

On the Australian market, two of the largest companies with rare earth exposure include Lynas shares (LYC) and Greenland Minerals and Energy (GGG).

Other locally listed rare earth companies include Arafura (ARU), which has a market cap of around $130 million, Alkane (ALK), which has a market cap of around $160 million, and Navigator (NAV), which has a market cap of around $90 million.

What’s a good one?

How do you identify the right rare earths company to invest in? Well, looking at rare earth shares is similar to looking at other mining shares.

First, ore grade is important. The higher the ore grade, the better. Good companies have an ore grade above two per cent. The best have an ore grade above 10 per cent.

The best rare earth companies will also have good distribution networks in place. If they have already signed up buyers, such as in the case with LYC shares, then even better.

The company should also have access to good infrastructure. There’s no good having a great deposit if you can’t make it to market.

Finally, keep an eye on the timing of the project. All mining booms operate in cycles. And in every boom, there are winners and losers. Getting to the market first is crucial in determining the winners and losers.

Bubble, bubble

When prices accelerate as quickly as we have seen over the last six months, markets can worry that a bubble is occurring.

However, although prices are currently high by recent standards, over the medium term, rare earths are likely to remain well supported. Besides, we believe mining shares in general will perform well in 2011.

For the moment, Chinese producers account for about 95% of the market. This won’t change substantially over the next three to five years, so unless the global economy bombs out – and people suddenly decide they don’t what to buy iPhones, iPads or similar products – then rare earth prices should remain high.