The Critical Metals Report: The Gold&Discovery Fund had impressive gains of about 70% in 2009 and 2010, but was down 35% in 2011. Do you believe you fully understand what happened to the junior miner explorers in 2011? Did you learn enough to protect investors from another year of negative returns?
Terence van der Hout: We were overweight in rare earths, which made us a lot richer in 2009 and 2010, but hurt us a lot more in 2011. Despite crashes, however, we still have a compound annual growth rate of 17% over the four years that we’ve been in existence.
We are an investment fund and we don’t take short positions by principle. We take long equity positions in companies that we believe will excel. But that also means that we have to accept crashes as they occur. We still believe in rare earths. The downturn in 2011 provided us with a buying opportunity.
TCMR: About 80% of The Gold&Discovery Fund is in precious metals, while the other 20% is spread out among other commodities, like uranium, natural gas and rare earth elements (REE). Do the gold plays act as “secure investments” in the portfolio, while the rare earth and other commodity plays act as the growth component?
TVDH: Not necessarily, because a junior that makes a discovery is going to add value whether it’s gold, uranium or rare earth-focused. Gold discoveries should be as much a part of our growth component as the REE or uranium juniors. Of course, the rare earths are subject to more cyclical market conditions than the strong fundamentals behind the gold markets.
TCMR: Rare earths are going through what is essentially the first sector down cycle because not many companies were in the space five years ago.
TVDH: That’s true. Rare earths are a very different market. Takeovers are our sweet spot and gold juniors very quickly get from discovery to takeover if they are good enough. The market realizes that potential.
In the rare earths, it’s somewhat of a different story. Companies often take more than five years to get to production. Success has a lot more work to do in the metallurgy. A lot more expertise is required. Takeovers, even for those rare earths [companies] that are in a fairly advanced stage now, are not imminent. Joint ventures with downstream end users may finance junior companies developing the deposits.
A number of companies in the rare earth sector should do well this year because they are at a stage where they will be able to show the world what their economics are like-and I think the world is hungry for more information about their true value.
TCMR: What are some items that could act as that trigger?
TVDH: Rare earths are subject to industrial production and general economic growth in emerging markets. China, India and Brazil need to continue growing. We believe that this will happen despite rising inflation in China and despite the west cautioning for a hard landing. Obviously, China has a virtual monopoly on the rare earth markets, but it will eventually need imported rare earths to keep the development path from going astray.
This may also be complemented by a return to normal industrial activity in Japan, which is one of the prime clients for heavy rare earths in the automotive and high-tech sectors. I expect that to gradually take place this year.
TCMR: Will China need more than it can produce on its own?
TVDH: There are different types of rare earths. China has plenty of the light rare earths, which are the more common and less expensive. However, it has few heavy rare earths. China does foresee shortages and has plans to begin importing more heavies.
TCMR: Rare earths are still not particularly well understood by investors. What myths about them would you like to dispel?
TVDH: There are misconceptions about the realities of supply and demand surrounding rare earths. Rare earths will continue to be indispensable in many high-tech applications. There will continue to be shortages, despite the current global economic downturn. That’s a very important fundamental to realize. There has been a lot of talk about recycling and alternative sources for rare earths, which sends the message that there is no shortage of supply. A large number of applications in rare earths can’t be substituted without a performance loss.
There are some recycling initiatives. However, the recycling initiatives that I’ve seen, for example, take magnets from the hard drives of computers that are often three years old and built to old specifications. Those magnets come with the performance of that time and the technology has moved on. That magnet might be obsolete. The magnet would probably need upgrading by adding dysprosium. If you’re going to do that, you might need to re-melt and make a new alloy to produce a new magnet. That’s not efficient or cheap. It might be cheaper in the end to just mine the stuff from the ground.
A lot of news stories talk about alternative sources of supply in Afghanistan, on the seabed, and even on the moon. These stories are more in the mythical sphere.
Rare earths also have incredible innovation potential. Their unique magnetic strength, connectivity, thermal capacity and resistivity to corrosion make them a prime focus for innovation. The potential of a technology discovery using these rare metals is about as large as it gets. We just don’t know what the future demand is going to be. The chances of a new use for rare earths are quite real because of their unique characteristics.
TCMR: Is the key to adoption establishing a consistent supply at a relatively reasonable price?
TVDH: Exactly. Rare earths may run up to a few thousand dollars per kilogram, but if only a few grams are needed to make an alloy, it’s only marginally more expensive from an end-product perspective. Scandium, for example, is alloyed with aluminum to get a very strong component that may replace composites for uses in the airline industry. Currently, scandium is about a 10-20 ton market. It’s completely insignificant. But should the airline industry take off, it could explode. That is something that other rare metals have the potential for as well, which is quite exciting.
TCMR: What are some of the REE positions that you’re bullish about?
TVDH: Recently, the term “critical rare earth oxides” has been introduced, which includes a number of the heavy rare earths, as well as neodymium. That aptly describes the type of company that we look for.
TCMR: Are there other trends that are appealing to you?
TVDH: There was a recent development in the tantalum sphere, which implies that the U.S. Dodd-Frank Act mandates users of metals to prove they are conflict-free. A lot of tantalum is produced from the Democratic Republic of the Congo, which is obviously a conflict area. This act will put a lot of pressure on the supply side for tantalum.
TCMR: What are some of the things that tantalum is used for?
TVDH: Tantalum is used in consumer electronics, such as cell phones and computers. It’s useful in products that are being designed to be small. Miniaturization is an innovative frontier that will require a lot more tantalum.
TCMR: Does your fund have exposure to platinum group metals (PGMs)?
TVDH: PGMs hadn’t appealed to us like the true precious metals, gold and silver, but platinum recently became very interesting. In South Africa, where about 75% of the world’s platinum production originates, the African National Congress (ANC) recently announced a plan to allow the South African people to benefit more from the proceeds of the mining industry. This plan was more positive than we expected in a mining-sense, but it included nationalizing the platinum industry. If South Africans see platinum as a strategic sector, it could impact price, supply or both moving forward. It could make any non-South African platinum producer very interesting from an investment perspective.
TCMR: Thank you for your insights.
Terence van der Hout is a senior researcher at the Netherlands-based Gold&Discovery Fund. The fund focuses on investing in world-class natural resources discoveries in precious metals, base metals and specialty metals, as well as undervalued start-up producers. Terence also distributes Strategy Metals Bulletin, a free, bi-weekly commentary on developments in the world of critical metals. To subscribe, please send an email to: firstname.lastname@example.org. Terence has a background in finance and holds a Master’s of Administration in political science from the University of Leiden.
Published courtesy of The Critical Metals Report – a subsection of The gold report – www.theaureport.com