EDITOR: | April 4th, 2016 | 2 Comments

Technology Metals Monthly – Has the decaf, soy latte set hit the Rare Earths Space?

| April 04, 2016 | 2 Comments
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Soy_Latte

Well, that was March. What can be said? No price recovery! No market bounce! I was sort of expecting a little action caused by a chocolate induced coma hangover being lifted, but no. Perhaps I’m too old school and remember times when Easter and chocolate was a time of celebration and recovery. Does our new-age, PC, decaf, soy latte set not have the same appetite for the traditional temptations? Well, they certainly are not showing any appetite for risk. Has had me thinking for a while now about what is going on in the investment world in general, but in particular the rare earths space. Everyone of the knowledgeable REO commentators espouse the fantastic fundamentals of the REO space, so why are things not responding?

First port of call – price movements. Remember I’m looking at a limited number of REO products, namely, Oxides of typically traded quality and FOB China, US$/kg. Again, as per last month, if you want very accurate prices against very accurate quality specifications at specific times, contact others. I am only trying to provide trends that can be used to indicate any shift in fundamentals. Also note if there is no price movement it is most likely the result of zero reported trade.

Chart1

So, no good news here. Plenty of support for a negative attitude, but what about those fundamentals?

During my research on the market I came across a couple of articles that I would like to share with you. It may help for you to see the thinking path I have come through so you may better understand why I have come to the conclusions I do. As a qualified process engineer and risk consultant, some of these detailed money concepts can be difficult to get to the root causes. Well, difficult for me anyway.

THE PERSPECTIVE – John Brogden, FAICD, Managing Director & CEO of the Australian Institute of Company Directors

Excessive “short-termism” is the scourge of the modern boardroom. It pervades decision-making and inhibits the positive outcomes of board deliberations.

In textbook terms, short-termism is a concentration on short-term projects or objectives for immediate profit at the expense of long-term security.

It can manifest itself in decisions based on very short time horizons or even through inaction by a board. A sin of omission is as bad as a sin of commission.

Effective strategies will certainly have short, medium and long-term objectives.

And, clearly, there are times when a focus on short-term risk or opportunities is necessary. This is particularly true in a time of rapid change or during a crisis.

The problems arise when short-term decisions are made in response to the instant gratification that shareholders, stakeholders and markets demand today, because it is easier than implementing a long-term strategy.

The consequences of those decisions can be acute. It can mean that opportunities for creating enduring long-term value are rejected or missed. It can mean that executives who receive incentives for short-term achievement take significant risks which do long-term harm, not good.

Despite this, the willingness of boards to balance long-term objectives with short-term needs is increasingly under question.

Directors can also be hamstrung by the instant news cycle and constant social media scrutiny, both of which are dominated by populist narratives that often fail to consider any real facts but quickly gain credence. 

If these words are representative of the public investment space, then what is the situation in the private equity space? Again, I’ll quote from others.

Bill Ferris AC, Chair of Innovation Australia. “Position on Private Equity”

In terms of its role, it’s here to stay, because private capital can do things in the market place that often public markets cannot.

The English invention of the limited liability corporation was one of the great inventions of the western world in terms of capital formation and “enabling stuff to happen”, but over time separation of ownership and management has increased in public equity companies. “In private equity, ownership and management are absolutely aligned and talking on a daily basis, and with a much clearer alignment of shareholder and manager interests than is possible in the public arena.

Private equity also has the advantage of time. Investments and decisions are made with a five to ten year horizon, but in many public companies “it’s more like ten weeks”.

So, how do these positions reflect in the REO space? Well, it is obvious that there is no public equity action happening. Why? Contentiousness time! In my view the investment world can be thought of as a continuum. At one end are the long term investors whose economic drivers are dividends and capital protection. At the other end are the speculators who are looking for a short term payout from buyout or share price lift. And in between there are others whose story is the topic of another thinking session. If I was to question you to assess who was investing in the 2010 bubble times, who would you identify? For mine, with a 10 year development time, it is difficult to identify equity with long term dividends in mind. They (and I was one) were looking at market gains as the bubble took hold. Motivation – greed and envy (my first root cause). That’s not being negative, it’s just human nature to see opportunity and to go for it. So a bubble beginning breeds its own future! But now the bubble has burst; there is no apparent speculative opportunity, so those players have gone elsewhere. The dividend hunters were never in this space, so does that mean that there is no public equity available in the REO space? Certainly appears so. This leads to the private equity opportunity.

Before I get to my thoughts on private equity, I need to detail some of my history, so you can see where my pattern of thought has come from. I spent 15 years with Rio Tinto, in operational / technical roles, and had a number of significant successful developments. Capital never seemed to be an issue, providing your Return on Investment (ROI) was acceptable (generally +15%), so when I moved away from the major company umbrella to the small cap development space, how things changed! Money was always tight! Even projects with +20% ROI were really hard work. Why was that so? Why was it so different? Thinking about that now I have concluded, or at least that’s my current position, is that a risk/reward conundrum has been established and needs to be answered to progress.

Rio Tinto funds its capital either from cash flow or by borrowing money. It can safely divert cash to new capital works (with a ROI of +15%) rather than directing that cash to dividends because the shareholders are long term dividend focussed and see long term value in growth. But note what is occurring here. Rio Tinto is risking either it’s own money or is borrowing from banks. It is taking almost all of the risk. So what proportion of the profits (NPV) of that capital works should go to Rio Tinto. Well, all of it of course. They (Rio) risked it, they (Rio) deserve the reward. Now look at a small cap exploration company looking to develop a REO project. Company capitalised at $25 million; has $5 million in cash; and needs $1 billion to develop a +20% ROI project. Things are very different. The money doesn’t come from within; there is no chance of shareholder funding (public equity); there is no chance of borrowing the money; so what is the solution to the conundrum? Next month, I will continue this discussion. I will explore the risk/reward conundrum further, particularly as it applies to small market cap REO development companies and the private equity opportunity.

Important Events of the Period

Well readers of InvestorIntel, haven’t we been treated to articles that question the future development of the hi-tech / green energy market? I am very pleased to be involved with writers of such distinction and to put it bluntly, honesty! As experienced engineers or practitioners in the field, we have been ignored for too long! It’s time our voices were heard! However. Repeat however, we are adding confusion to an already confused investment world. If we paint a picture with too much negativity in it, it will be difficult for the investment world to see a positive future. And we don’t want that! So for mine, whenever I go to print with negative words that sometimes cannot be avoided, I will try to balance that with positive as well. Simply put – don’t only present the problem, present a semblance of a solution as well.

  • There is a new factory in China that is adding rare earths to aluminium to produce a more cost effective cable. Significant opportunity in power distribution. Early days, I’ll keep you posted.
  • There does not appear to be any backing away from the leading economies hi-tech / green energy aspirations. Can only continue to be good for the fundamentals of Technology Metals. Is there another significant opportunity on the horizon? (Note to self – never predict a bubble)
  • The future of the rest of world (ROW) REO space is on display this quarter with the publication of the Q1 2016 position of Lynas Corporation.
  • Caveat Emptor. The expansion of the by-products argument seems to be gaining traction. This will have a tempting benefit to the NPV of a project as it increases revenue. Watch out however on the increase in CAPEX.

Recommendation for April: drop the decaf!


Steve Mackowski

Editor:

Mr Mackowski is a qualified engineer in mineral processing with over 30 years technical and operational experience in rare earths, uranium, industrial minerals, nickel, kaolin ... <Read more about Steve Mackowski>


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Comments

  • Tracy Weslosky

    Thx Steve. I recently gave up coffee, and I tell you – decaf soy lattes do NOT taste as good as the real thing, so I am with you! On some good news, I see that rare earth company Search Minerals, or $SMY.V was up + 54.55% in March….

    April 4, 2016 - 11:31 AM

  • Alan Levy

    Steve:

    As you well know, the last major price spike in the rare earths was a result of a slight “tiff” between China and Japan. And in this rock-papers-scissors Great Game of strategic metals, politics seems to cover economics.

    Therefore, I found it noteworthy to see that China is talking about banning some rare earth imports from North Korea. The following excerpt is copied and pasted from an April 5th BBC article:

    “China has said is restricting trade with North Korea, announcing bans on gold and some coal imports and jet fuel exports, in line with UN sanctions.

    The commerce ministry is also banning the importation of so-called “rare earth metals” used in high-tech goods.

    The UN Security Council voted in March to increase the sanctions.

    The unanimous decision came after North Korea carried out a fourth nuclear test in January and launched a long-range rocket the following month.

    The BBC’s Robin Brant in Shanghai says this is a step closer to fully implementing the UN sanctions which China backed. Some doubt Beijing has been fully adhering to them.

    The Chinese ban on exports is linked to any fuel or oil products that could be associated with North Korea’s nuclear programme.

    Our correspondent says these restrictions are likely to hurt as China accounts for the vast majority of trade with North Korea and mining is a key source of currency for the North.

    According to AFP news agency, quoting Chinese customs figures, the coal trade between the neighbours was worth $1bn (£704m) last year.

    But China’s commerce ministry said the trade in coal would still be permitted as long as the revenue was intended for “people’s well-being”, Reuters news agency reports.

    Some critics have likened this to a de facto loophole which could give China wiggle room to maintain trade, our correspondent says.

    North Korea is China’s third biggest supplier of coal, delivering 20m tonnes last year, Reuter reports.”

    BTW, I always enjoy your writings. A good read!

    April 5, 2016 - 4:36 PM

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