Disconnect between rare earth stock and commodity prices is a value pointer

Rare earth stocks, like the rest of the mining sector, have been sold down for much of the past six months, but three clues can be found, which point to the potential for a strong recovery.

The first clue lies in a disconnection between share prices and underlying commodity values with prices for leading players in the rare earth business falling even as prices for what they sell continue rising.

Lynas Rare Earths (ASX: LYC) is the best example of the divergence between the stock and commodity markets.

On the ASX, Lynas has fallen by 25% since the start of the year, though it just reported record sales receipts of $351 million for the June quarter thanks to its most valuable product – a mix of neodymium (Nd) and praseodymium (Pr), selling for around 75% more than the June quarter last year.

That product, which is generally referred to as NdPr, is used in the permanent magnets found in a variety of technologies ranging from electric cars to offshore wind turbines and mobile ‘phones.

Nd and Pr are two members of a 17-element family of metals (incorrectly called earths), which have a variety of increasingly important uses in modern technologies.

Capital continues to flow into rare earths

Despite the sell-off in rare earth stocks as investors duck for cover ahead of a possible recession, the flow of capital continues to flood the rare earth sector to fund strong and growing demand for the material.

This the second clue for a potential strong recovery.

Recent examples of rare earth investments and capital raising include:

• Lynas building a $500 million rare earth processing facility at Kalgoorlie in WA to undertake early-stage processing of ore mined at nearby Mt Weld before it is sent to Malaysia for upgrading.
• Hastings Technology Metals (ASX: HAS) is reported to be preparing a $200 million equity raising as the final step in funding for the development of its world-class Yangibana project in WA.
• Iluka Resources (ASX: ILU), a mineral sands miner, is investing $1.2 billion in a rare earth refinery alongside its Eneabba sands mine in WA, with the target being the extraction of rare earths from monazite sand previously stockpiled.
• Arafura Resources (ASX: ARU) is seeking $40 million in fresh funds for its proposed Nolans mine near Alice Springs in the Northern Territory.
• Heavy Rare Earths (ASX: HRE), which is yet to list, is seeking $6 million in to help fund exploration on tenements near the WA gold mining centre of Norseman; and
• Extensive funding flowing from Australian Government economic development agencies to encourage the creation of a major rare earth industry able to meet growing global demand.

China’s continued dominance

The third clue pointing to rare earths being a sector of the market which should recover strongly is the continued dominance of China as the country which controls almost every aspect of the industry.

China’s control makes the rare earths business geopolitically sensitive which is why Australian companies are receiving the close attention of the US and European governments

After the experience of Russia limiting the supply of gas to Europe there is concern that China could “weaponise” rare earths – repeating a tactic used in a 2020 trade dispute with Japan when it temporarily cut off supplies.

Australian Government rare earth funding, which is liberally available to local participants, is an extension of the original government-backed sponsorship of the Australian industry which saw Lynas win the support of the Japan after it was stung by a Chinese embargo.

Commercial and national security drivers

Unlike most mining industries, rare earths have the twin drivers of commercial and national security factors, adding to their investment appeal.

The June quarter report of Lynas highlighted the strength of rare earth demand as well as the challenges of cost increases being felt in all industries.

The record $351 million received for material sold in the latest quarter came despite a 26% fall in the volume of rare earth oxides produced, including a 6% decline in NdPr.

A primary cause of the production shortfall was an interruption to the water supply at the company’s Malaysian processing facility – a problem being overcome by modifications to the plant.

Across the board cost increases, especially for shipping and chemicals will eat into Lynas’s annual profit which is normally filed at the ASX at the end of August.

Lynas profit forecasts

However, a hint of what’s to come can be found in recent investment banks reports, including Goldman Sachs tipping underlying pre-tax (EBITDA) earnings of $619 million, up 163% on last year’s EBITDA of $235 million.

Much of that forecast profit increase is already factored into the Lynas share price which is up 43% on this time last year (but down over the last six months as mentioned earlier), prompting Goldman Sachs to retain a neutral view of the stock with fair value set at $8.06 – less than last sales at $8.37.

Macquarie Bank is more enthusiastic, tipping Lynas as a buy with a price target of $12.50 based on a spectacular profit trajectory with pre-tax earnings tipped to hit $1.1 billion next year.

Canaccord Genuity reckons Lynas is heading back up to $12, though EBITDA will not clear the $1 billion mark until 2024.

The difference between profit estimates and share price forecasts from Goldman Sachs and Macquarie Bank is an example of the difficulty in getting an accurate reading of a complex industry which is essentially still in its infancy.

But for investors prepared to ride out the bumps associated with any new business the rewards could be significant because the underlying demand for rare earths is not in doubt even if there are certain to be more issues such as the water problems faced by Lynas in the June quarter.

Major upcoming developments

News flow over the next 12-months is certain to boost interest in the entire rare earth sector with major developments that include:

• Progress on Lynas’s Kalgoorlie project and an associated heavy rare earth processing facility being built in the US in association with the US Department of Defense.
• Iluka making progress with its monazite treatment project, and
• Hastings building its Yangibana project, along with progress by Arafura at Nolans and Australian Rare Earths at its Koppamurra project on the South Australian/Victorian border.

As a sector, Australian rare earths are emerging from being high-risk exploration plays and on track to become a business on global significance.

Ionic clay-hosted rare earths in Australia

Other emerging regions to watch in Australia’s rare earths space include South Australia’s Eyre Peninsula where iTech Minerals’ (ASX: ITM) has made ongoing wide and high-grade hits at several prospects.

Also in South Australia, Taruga Minerals (ASX: TAR) is evaluating the clay-hosted rare earth potential at its Morgan’s Creek prospect, within the Mt Craig project.

In the Murray Basin that spans South Australia and Victoria, Resource Base (ASX: RBX) has pegged up 2,600sq km of tenements, which make up its Mitre Hill project. Drilling at the some of the tenements has already generated numerous shallow and high-grade rare earth intercepts.

The Murray Basin is described as an emerging globally significant ionic clay-hosted rare earths precinct.

Australian Rare Earths (ASX: AR3) has tenements that border Resource Base’s in the region and has developed a resource of 81 million tonnes at 785 parts per million total rare earth oxides for its Koppamurra project.

Clay-hosted rare earths are considered more valuable because they are easier and less costly to mine and process than hard rock deposits.