How a naval confrontation in the South China Sea created a global investment bubble -- and cost me half my life savings.
"What's the definition of a mine? A hole in the ground with a liar on top."
The most famous aphorism about the mining business is usually credited -- possibly apocryphally -- to Mark Twain, who before assuming the mantle of America's great literary wit was just another mining speculator gone bust. But generations of fleeced investors since Twain's day would nod angrily in agreement -- losing a fortune on too-good-to-be-true mining deals is a tradition as old as mining itself.
So it goes with rare-earth elements, a group of materials used in the manufacture of various high-tech applications and the object of the latest subterranean fad. Since a border dispute between China and Japan pushed rare earths into the headlines last fall, prices for some of the elements have shot up to an incredible 1,000 percent of what they were just three years ago -- and as in Twain's day, there is no shortage of smooth-talking suits who will tell investors this is only the beginning. I should know: For a few months, I was one of the suckers.
Before we get to that, a brief geology lesson: "Rare earths" is the catchall phrase for 17 elements mostly near the bottom end of the periodic table that are essential for cutting-edge optical and magnetic applications in hybrid cars, wind turbines, iPads, mobile phones, and smart missiles, among other things. What rare earths aren't, however, is rare -- in years past, they were mined everywhere from Florida to Indonesia -- or terribly valuable. In 2009, global sales of all raw rare earths combined came to less than $2 billion -- half the market for palladium alone, and 1 percent of the market for gold. These aren't exactly precious gems: Most rare earths are priced by the ton, not the ounce.
China started cornering the rare-earths market in the 1990s not because it was the only one with the stuff in the ground, but because everyone else gave up. Mining rare earths requires some of the most invasive and ecologically destructive open-pit extraction practices in the world, and China's lack of environmental regulations and its cheap labor meant that it could easily undercut even the biggest suppliers. The one active mine in the United States, operated by the company Molycorp in Mountain Pass, California, halted production in 1998 after a radioactive-waste spill and was shuttered four years later.
For fly-by-night speculators, rare earths couldn't be packaged more attractively. No amount of polite explanations like the above will strike the word "rare" from their name, and the stuff has a knack for attaching itself to headline-worthy buzzwords: "China," "green technology," "iPhone." The rare earths' names -- dysprosium, neodymium, yttrium -- may be a mouthful, but everyone knows how to spell "opportunity." Many companies currently dealing in rare earths have seen their stock valuations jump more than 500 percent on speculation alone, even as global demand for what they're selling has remained more or less flat.
I first heard about rare earths last February, while researching the link between mining -- including rare earth mining -- and guerrilla conflict in rural India. Almost as an afterthought, I noticed China's monopoly and the potential for a big price jump should China decide for any reason to twist the screws. Acting on the hunch, I dumped my meager life savings -- about $9,000 -- into the rare-earths sector, and waited for the payoff.
Investing in speculative mining companies is a bit like buying lottery tickets -- for every firm that pays off, there are dozens whose promises of vast riches disappear into the fog of stock dilution, mismanagement, environmental catastrophe, and fraud, as well as the ever-looming possibility that companies digging for pay dirt will find only the regular kind. The business is full of cautionary tales like that of Bre-X Minerals, a small Canadian gold-mining company that opened up shop in an Alberta basement in 1994. Bre-X started putting out spectacular press releases about phantom gold findings on its Philippines property; the stock soared, and soon the company was worth almost $5 billion before a single ounce of metal was mined. By 1997, however, its claims couldn't be substantiated, and one of the company's geologists died under mysterious (and ambiguous) circumstances. Individual investors and pension funds eventually lost everything, and the cases are still clogging Canadian courts.
Then there are the geopolitics: Events perpetually threaten to upend whole mining subsectors, with countries flooding markets or nationalizing firms more or less on a whim. For rare earths, with their Chinese near monopoly and high-tech military applications, the odds of the whole market being turned on its head were particularly good -- and that was exactly what happened on Sept. 7, when a Chinese fishing boat collided with two Japanese naval vessels along a disputed border in the South China Sea.
Within days, China halted its rare-earth exports to Japan, whose high-tech manufacturing sector is heavily dependent on them. The Chinese government insisted its actions had nothing to do with punishing Japan, but the countries on the receiving end of China's rare-earths exports, and technology exports that use them, didn't buy it.
Believing that China intentionally used its monopoly position to create an international incident, U.S. Secretary of State Hillary Clinton announced that securing rare earths would be a focal point of China/Japan G-20 discussions in November, and the issue vaulted up the diplomatic agenda. On Sept. 29, the U.S. House of Representatives introduced and fast-tracked the Rare Earths and Critical Materials Revitalization Act, which was as much a sheepish admission of U.S. ignorance on the subject as a coherent plan for future security. On Oct. 16, the United States complained to the World Trade Organization over China's embargo; four days later, China banned exports to Europe and the United States, too.
Now things were really cooking. Every breathless headline gave a steroidal boost to the penny mining stocks in my account, and within a few weeks a 10 percent gain in a day was ho-hum. By that point, I was hooked. The promise of getting in on the ground level is a powerful investing drug: There's nothing quite like the thrill of sitting at a computer and seeing your account go up by $100 almost every time you hit refresh. Cashing in on one of the "once in a generation" opportunities you always hear about made me feel like I gamed the system.
But cleaning up by day-trading stocks is just about the hollowest victory imaginable. By the end of each day, the easy-money euphoria would give way to the leg and arm cramps from remaining motionless save for my mouse-clicking hand, and hunger pangs from being too riveted to the screen to eat anything all day. By the time I gimped back home to my nonplussed girlfriend, I'd already be feeling like I was epically wasting societal space. Then I'd wake up the next morning, put on a pot of coffee, and start all over again.
Among the stocks I'd bought was Molycorp, the only U.S. company in possession of a genuine rare earth mine. After churning out raw rare earths for decades, Molycorp had closed up shop in 2002 after China's market flooding and tightened environmental regulations made mining unprofitable. Once China started scaling back, however, Molycorp saw the opportunity to start up its Mountain Pass mine again. The company launched an IPO in July to secure the funding needed for new operations, with which it promises it will be able to provide up to 65 percent of all rare-earth needs outside China by 2012. Less than six months later, Molycorp's shares were up 500 percent, and its value on the stock market is worth far more than global annual sales for all rare-earth companies: about $4 billion. CEO Mark Smith said himself in October that "there may be a bubble" in the rare-earth industry (though he backtracked quickly after realizing that his shareholders might not find that candor useful). No matter -- the company has doubled in value since.
Meanwhile, 15 major mining companies and over 100 minor players are ramping up production and exploration in places as varied as Australia, Canada, Estonia, Greenland, India, Kazakhstan, Mongolia, Russia, South Africa, and Vietnam. Their schemes range from the plausible to the preposterous.
Among the beneficiaries of the continuing panic is a Vancouver-based company called Rare Element Resources. Originally a curious hybrid of a gold-mining company and an investment firm called Spartacus Capital, the firm was renamed just before the rare-earth sector started to take off. In a phenomenal bit of luck, the newly minted enterprise was able to snag the stock-ticker symbol REE -- also the shorthand for "rare earth elements" -- and many people have since invested in the company thinking that they were buying the hottest minerals on the market.
In fact, Rare Element Resources' total holdings consist of a few small plots of land, the most promising of which had been abandoned by at least three previous miners (including Molycorp). Unlike the Bre-X scam, the company's Wyoming land does indeed have rare earths, but they are in small concentrations and are mostly the less-desirable sub-group of the elements. The company's chief financial executive and spokesman, Mark Brown, and secretary, Winnie Wong, are regulars on Canada's penny stock scene -- they've run at least 18 different businesses with names like Deal Capital, Cordova Industries, Apoquindo Minerals, Pivotal Corporation, Globemin Resources, and Everclear Capital.
The company's 402-square-feet headquarters in downtown Vancouver is also listed as headquarters of at least seven other ventures. The firm has no revenue, no production, and even if their rosiest press-release hopes and dreams come true, their first actual sale of rare earths won't happen until 2015, long after the other 20 rare-earth companies further along in the production process have locked up all the major buyers.
A charismatic man with an encyclopedic familiarity with the mining business, Brown told me that rare earths were the new oil -- a business whose market is more than 1,200 times the size of rare earths' -- but he also conceded that his new line of work was "a very, very high-risk business."
"Only one in a thousand companies will actually find an economic mineral deposit," he said, "and you don't know which one is actually going to find something." Plenty of people seem willing to bet that his firm will prevail over the long odds: Rare Element Resources is currently worth nearly $500 million.
Cooler heads have weighed in on rare earths, but since the frenzy began they've largely been ignored. Six months before the China-Japan incident, the U.S. Geological Survey issued a report showing that the world has a 1,000-year global supply of proven rare-earth reserves, 63 of them outside China. The U.S. Defense Department released its own assessment in November saying that the national security implications of China's rare-earth lockdown -- a key factor in the initial burst of panic -- had been overblown. Demand for rare earths, meanwhile, is almost totally inelastic, and the market is already adjusting to concerns over a Chinese monopoly. The big buyers in Japan started importing from India and Vietnam three years ago, and Molycorp alone may be delivering more than six times what the United States needs by 2012.
So, who are the winners in this saga? Not me -- as the rare-earth market went from ignored to overvalued in a blink of an eye, I went from smug satisfaction at being ahead of the curve to kicking myself for selling out way too early. I lost half my stash betting that people would have come to their senses by now, and left the day-trading game in pursuit of more rewarding ventures, like frantically scanning fantasy football waiver wires. The other small-time investors holding on for the roller-coaster ride likely won't fare much better -- they'll be cleaned out by betting on the "one in a thousand" companies once the quarterly sales figures start coming in. That leaves only the mining executives: If they're smart, they'll get out before the whole game goes south -- and prove the old adage right all over again.