This article was originally published on January 29, 2019, when we first saw these ads from Cabot. The ad is still running, with little to no changes or updates, and the article below has not been updated.

When everyone’s worried about a trade war, look for the stocks that benefit from superpower rivalries… that’s a rational-sounding argument, and it’s at the heart of the latest pitch from Cabot Global Stocks Explorer, which used to be called Emerging Markets Investor (currently $197/yr, with Carl Delfeld at the helm replacing the recently retired Paul Goodwin)… with ads that are baited with a “secret $1 stock.”

So what is it? As usual, we’ll sift through the clues and identify it for you, share a few thoughts, and then you can go forth, researchify to your heart’s content, and make your own choice. Ready?

The special report they’re peddling in these ads is called “China’s Hardball Trade Move Will Send This Stock Soaring” … and the first part of the pitch lays it on good and thick:

“U.S.-China rivalry will soon send this secret $1 stock soaring

“… this stock reached $20 during the last confrontation

“Not long ago, the value of this company’s products soared 618% in three weeks

“Proven potential to turn $10,000 grubstake into $200,000

“CEO says recent pace of orders “absolutely buoyant”

“The company has held up well in recent turbulence, and its prospects for future growth are outstanding. When you read what I’ve learned, you’ll want to add it to your portfolio immediately.”

So… what is it? The ad goes into a long spiel about the strategic brinksmanship between the US and China over trade, but also between the US and several other major economies over a small sliver of the global materials business: Rare earth elements.

China dominates the production of rare earth elements (sometimes called rare earth metals or magnets), which are not all that rare but are rarely found in economically viable concentrations that are worth mining… and they’re also difficult to produce and refine. The list includes yrbium, tantalum, indium, neodymium, dysprosium, yttrium and lots of others that are even harder to spell, and they are indispensable for lots of critical modern electronics. Here’s a bit from the ad:

“Rare earths make possible all sorts of products from cell phones to advanced weapons systems, communications, electronics, aircraft engines, robots and hybrid batteries.

“For example, the addition of aluminum alloy with only 2% rare earths can cause the hardness to be nearly double that of pure aluminum.

“Here are three key things you need to know about these essential materials.

“First, the real value of these materials is their unique electrical and magnetic properties that allow for miniaturization and much lighter, stronger, resilient and efficient components—making the products we buy smaller, faster and more powerful.

“Second, rare earths are very difficult to extract from common ores like nickel, copper and zinc.

“Third, while America has slept, China has become the Saudi Arabia of rare earths.

“As Deng Xiapeng put it – ‘the Middle East has oil, China has rare earths.’

“In rare earths and many rare metals, China has a commanding 85% market share of global production.

“Furthermore, China is doubling down on its commanding lead by having its state-sponsored firms gobble up reserves and mining assets all over the world.”

So yes, we’re being teased about some kind of company related to rare earth elements. Prices for these elements are pretty well controlled by China, which has used its dominance in rare earth mining and processing to onshore more manufacturing over the past 20 years — cutting export quotas, but letting companies who build in China use rare earths there at low cost. It seems as though China flooded the market starting in the 1980s and 90s, took on the dirty and unpleasant refining work that no one else really wanted, gutted prices to the point that most outside projects weren’t economic, and ended up essentially undercutting or buying out most of the non-Chinese mines and refining facilities.

And the ad says that China might again pressure the industry if the trade war continues…

“If provoked into a corner by trade tactics, China could play a devastating trump card counterpunch due to its dominance of rare metals and rare earths that it has cornered—while America slept.

“Even The New York Times reports that: ‘Beijing could use its dominance to cut off key parts of the global supply chain.’

“This could mean tremendous investment opportunities for you—like the one that soared 618% in three weeks.

“China could quietly limit access to these important resources even more than it did in 2018 when it cut back production 36%—according to Adamas, a research firm.”

That big 618% surge happened when China and Japan had a showdown over a ship accident in disputed waters, back in 2010, and China cut off Japan’s rare earths supply — and apparently, we’re told, that’s also when this stock last soared to $20 (it’s around $1 now)… so that’s the short-term bet, I guess, that there will be some ugly catalyst in the trade dispute (or in the even-more-disputed areas of the South China Sea) that causes China to cut off supplies again, driving prices up.

Will that happen? I have no idea, tensions are obviously high, but predicting how US-China trade negotiations will go is way above my pay grade.

But I can tell you what stock they’re touting… this is almost certainly our old friend Lynas (LYC.AX in Australia, LYSCF OTC in the US), a small rare earths miner and refiner (mining at Mt. Weld in Australia, refining in Malaysia) that has long been touted as the “outside China” solution to the world’s hunger for more rare earth elements.

Lynas has been covered in this space quite a few times, I even owned it for a while during the first rare earths mania of the mid-2000s… and it is a real company, with a real mine in Australia and processing/refining plant in Malaysia, though there’s plenty of risk to go with that reality.

To give you some idea of that risk, here’s a chart of Lynas shares in the 7-1/2 years since their Mt. Weld rare earths mine was officially opened in mid-2011 (at a cost of $100+ million), the first significant rare earths mine outside of China in many years:

So yep, the rare earths bubble caused by the China/Japan clash did create a huge price spike… but that was pretty much the last time the stock traded at the all-time highs of about $20, and it’s been a steady path down since then. I felt foolish for selling at $5 back in 2009, but by 2013 that foolish feeling had pretty much morphed into (unjustified) smugness (unjustified because I sold because I had another opportunity that required the money, not because I knew it would fall to $1 ten years later… but still, my brain can’t resist seizing on any moment when I can pretend I’m wise and prescient).

Frank Curzio was on board this one recently, too, teasing it late last year (though I didn’t actually write about those ads), so Cabot isn’t the only one who saw the headlines about “trade war” and thought, “hey, I wonder if China will be throwing its weight around in rare earths again soon?”

And well they might, I’m sure the order book has been strong for Lynas and, yes, the CEO did say last Fall that the orders from Japan were “absolutely buoyant” … though Lynas faces more imminent operational trouble that’s probably distracting management from filling those orders.

The most challenging issue for Lynas is not mining, they have done well at that and they finished another big phase of mining work at Mt. Weld recently… the challenge is refining, which is a dirty and ugly business (which is part of the reason why China dominates — few people want rare earths refining facilities in their neighborhood, especially when prices are low). Lynas’ challenges over the years have in many ways revolved around their struggles in getting their Malaysian refining plant permitted and built and commissioned… and that continues now, with Malaysia holding up license renewals that are due this year over stated fears about the risk of radioactive and other mine waste storage being held on site.

Is this mostly a strategic fight, Malaysia doing a favor for China? I doubt it, the plant has been a political football from the beginning, and was widely protested when it was first permitted. Still, you never know… Malaysia has recently been seen as possibly leaning a bit toward Japan and away from China when it comes to regional politics, but China continues to have huge influence over its little neighbor.

So there’s plenty of risk, and it’s likely to make the shares very volatile… but yes, Lynas is the only meaningful rare earths miner and refiner outside of China, despite the dozens of juniors that have ridden past waves of rare earth mania on the promise of establishing strategically important non-Chinese production. It turns out, when prices are low, that no one really wants to pay a lot more or build environmentally challenging mines and processing plants (rare earths typically are found alongside uranium or other radioactive materials, though not always) in order to get non-Chinese rare earths. Maybe that strategic imperative will change in the future, but it would probably take either major government initiatives or some big investments by end users like the big electronics and car companies.

And it looks like Lynas might be able to keep their license by just shipping their waste back to Australia (or somewhere else), which should be feasible and would presumably allow this fight between Lynas and its Malaysian hosts to de-escalate without the plant being closed — the boats that deliver ore from Australia can travel both directions, after all, and this is not highly radioactive stuff so I imagine it should be transportable on regular ships. That cost will be meaningful if rare earth prices stay relatively low, as they are now, but would not be a big deal if prices spike again and people are willing to bid up to buy non-Chinese production.

How about financially, is Lynas making money from their production of these rare materials?

That’s where it becomes a bit more of a bummer. Lynas has never reported a profit until this past year, despite five+ years of active mining… and since the mine opened in 2011, the share count has ballooned from 167 million to 600 million as they’ve raised more money to keep the work going.

Still, last year was pretty good — the year ending last June included their best revenue yet, by far, at $290 million… presumably that’s just because of better prices, because their cost of goods only climbed by 7% while the revenue grew by 50%. And their costs might go up as they work to settle this Malaysian dispute over waste material (we don’t know how that will end, but you can see Lynas’ December letter about it here), but if prices jump considerably, as they should if there’s another real standoff between China and the rest of the world over rare earth export quotas, Lynas would presumably enjoy the benefit of that.

You can see the full quarterly update from Lynas here, released last week. They sound optimistic and the numbers for the end of 2018 seemed pretty solid, despite the fact that production was a bit low in the December quarter as they cut off production early because they maxed out their permitted quotas… but, of course, the A$10 million in cash they generated in the quarter can’t justify a A$1 billion valuation, my interpretation is that even the shares at $1 assume that rare earths prices will rise someday.

I have no idea what the rare earths market will bring, but there are always lots of juniors who are sitting on or exploring deposits, despite the fact that almost none of the dozens of “advanced” discoveries in the past 20 years have actually become mines — Lynas is the real standout in the group, but its weak financial performance as an operating company probably serves to scare off more rare earths financiers… I would assume that most of the juniors are just hoping for another bubble to form so they can raise lots of money (or so insiders can sell their shares), but Lynas isn’t a junior anymore — they get valued based not on dreams of the future, but on their actual revenues and profits and permit renewals and contracts, and that’s not nearly so fun.

Probably the shares will spike dramatically if rare earths go up 600% again because of the trade wars (or for whatever other reason), but it wouldn’t be surprising if the crazy little juniors went up even more… and if we do get another spike, keep that last one in mind: As soon as China lifted its export quotas, rare earths prices collapsed again, Lynas slowed down and raised money to stay alive, and it seemed that pretty much all the other rare earths exploration and development projects around the world went into slowdown/survival mode.

Remember Molycorp, the big US hope for relaunching our domestic rare earths production? That went bankrupt in 2015 in the wake of those price collapses over the previous few years — it came back to the market and still exists as Neo Performance Materials (NEO.TO, NOPMF), which produces value-added rare earths stuff, but it no longer aims to mine or refine the materials itself and its old Mountain Pass mine in California was eventually sold at auction for $20 million… with the operators now shipping ore to China for processing).

Moves have been big in this space in the past, to be sure, but these have not tended to be “buy and hold” investments… so if you do gamble on Lynas or any of the others in hopes of another price spike, you might want to keep one eye on the exit.

So what do you think? Ready to bet on the next rare earths price spike coming out of the trade dispute? Think Lynas will be your best bet if that happens, or do you prefer one of the tiny and even more speculative juniors? Someone else? I know that many of you went through the rare earths bubble last time around and, depending on when you sold, have either stories to brag about or wounds to lick, so feel free to share your thoughts with a comment below.