Precision Points: Rare earths are all the rage, but these unloved commodities could hide bigger opportunities

In Precision Points, Precision Funds Management executive directors Dermot Woods and Andy Clayton draw on insights from two decades on the front lines of equity markets to share their expertise with Stockhead readers.

Few great stock pickers simply follow the herd, and the rush of risk capital into rare earths has Precision Funds Management’s Dermot Woods and Andy Clayton thinking hard about where they can find value is less loved commodities.

The tailwinds for rare earths are well documented – government support to create a bifurcated market and supply chain that dulls China’s influence, rising demand, centrality to modern technology and particularly military products, and ‘floor prices’ that could underwrite cashflows.

But the market remains small, niche and dominated by established players.

“It is very difficult for juniors to become a profitable producer of (rare earths),” Clayton said.

“A Lynas (ASX:LYC) took 10 years and if it wasn’t for the Japanese funding from Sojitz to help them through (Lynas wouldn’t have survived).

“It is technically very challenging and it’s taken them 10 years to really get to there.”

“They have a rarity value in the stock market,” Woods added. “It’s pretty hard to make economic sense of the share price on a day to day basis versus the rare earths price … but then other things are getting priced off that, which is a dangerous precedent.”

Clayton says the rush of capital into ‘critical minerals’ is showing the animal spirits of the share market have returned in the past 3-4 months – speculative stocks can deliver ‘terrific gains’. But realising those gains at the right time can rely on a bit of luck or ‘greater fool theory’.

“If a project’s really hard and the IRRs are really low, what tends to happen is it gets massively debted up, in which case your returns are a very, very long way away,” he said.

“In the meantime, for a return, you’re dependent on greater fool theory. You want somebody else to come along who is more optimistic about the future than you are.”

Looking elsewhere

That’s not to say investing in critical minerals, and rare earths in particular, is the wrong thing. But rather that capital returns could be realised quicker in commodities where fewer investors are looking.

One Woods and Clayton keep a close eye on is coking coal, and especially the sector’s leading standalone name Whitehaven Coal (ASX:WHC).

Around half of the roughly 36Mt of coal produced annually at Whitehaven managed sites is met coal, which carries a price premium over thermal.

But increasing operating costs in Queensland, where its Blackwater and Daunia mines are based alongside a number mined by other companies, has made what would previously have been considered high coking coal prices marginal.

“Coking coal obviously has been starved by government policy. And the flip side of that is people, including us, you take your eye off it,” Woods said.

“I think most people would think at US$200/t that Aussie coking coal assets are making a lot of money because they used to, but they don’t anymore because the Queensland Government (royalties) have come for 40% of their marginal dollar.

“The revenue line’s got attacked by the Queensland Government royalties and their cost line’s being attacked by changing labour policies. So actually US$200 is no more like what US$140 used to be.”

That’s made plenty of coking coal production marginal, with prices increasing around US$25/t in recent weeks as loss making tonnes have left the market.

Long development timelines for many rare earths hopefuls mean the return for the equity holder, if they keep hold of their shares, could be a decade away.

For coking coal, owning quality names can deliver leverage to price movements in the short term.

“If the coking coal price moves 20 bucks from here an actual return for a Whitehaven shareholder is less than six months away and at the same time, they’re buying back capital,” Woods said.

Turnaround story

Other commodities seeing little interest right now include oil and gas and nickel.

Prices for the latter have been stuck in the US$15,000/t range, with negative sentiment over a string of Australian mine closures killing interest in the sector.

But at least one large producer, the Indonesian-focused Nickel Industries (ASX:NIC) has been plugging along at thin but profitable margins with the commodity dragging along at its bottom.

“The nickel price has done nothing, but it has a history of moving around an awful lot, and it hasn’t for the last three years,” Woods noted.

“So everybody assumes it’s dead forever., and you have ready made operations that there’s now a bit of capital discipline coming in there and a bit of government driven constraint.

“If the price moves, they make massive amounts of money.”

Nickel Industries is one of the world’s largest nickel producers, having started from next to nothing when Indonesia banned shipments of unrefined nickel ore more than a decade ago.

That sparked the Norm Seckold-chaired company to become a downstream producer of nickel pig iron and then HPAL nickel for battery applications, backed by technology from shareholder and Chinese stainless steel giant Tsingshan.

Woods said they’d become more interesting since the company restructured its debt in September, issuing US$800m in senior unsecured notes at a coupon of 9%.

The issuance extends the deadline for the maturity on the firm’s debt from October 2028 to 2030, when demand and supply balance is expected to be more favourable for nickel producers.