From the research report entitled “Rare Earth – Our Top Picks” by analyst Luisa Moreno at Jacob Securities Inc.

The rare earth sector is fairly new to investors and it is experiencing a great deal of growth and volatility driven mainly by the dramatic cuts in export quotas from China. This has led to periodic frenzies in stock prices of rare earth companies that tend to track and respond to news related to the Chinese rare earth policies. While constraints in the supply of these materials would certainly have significant effects on the price of these elements and share prices, there are several other factors that should be taken into consideration in a going concern valuation of rare earth mining companies, as listed below.

Mineralogy

There are approximately 200 minerals that host rare earth elements and only about10% of these have the potential to be economically mineable. Most of the extractable resources, however, are associated with only three types of minerals: bastnasite, monazite and xenotime. The type of mineral is very important as it ultimately determines which elements will be extracted – that is, which REE group is to be extracted, light rare earth elements (LREE) or heavy rare earth elements (HREE) – the mining and milling method (surface or underground mining and the separation of the minerals from the waste rock), the complexity of the extraction of the elements from the minerals, processing costs, environmental implications, and reclamation costs and liability.

Ore Grade

The grade or concentration of an ore mineral has a direct impact on production costs. Higher grades generally mean a higher percentage of elements can be extracted, which normally translates into lower unit costs and better margins. The costs associated with the extraction and the processing of the rare earth elements (generally higher than those of major industrial metals, e.g. copper) are weighted against the value of the contained elements to determine the cut-off grade (i.e. the grade of material below which mining is not economical). High grades usually favour the success of feasibility studies. Furthermore, if the deposit has a disorderly ore quality distribution, there is a simple rule of thumb that applies to the cut-off grade — if the price of resources increases (decreases) in a sustainable fashion, the cut-off grade should decrease (increase). Hence, mines with higher ore grades have a better chance of staying in production when prices fall.

Metal Equivalent Approach

The Metal Equivalent Approach is commonly used when assessing deposits with multiple elements. Given that the individual rare earths have dramatic differences in prices and some are used in completely different applications, they are in essence different materials. We think that security regulators should mandate that REE prospectors and miners use the Metal Equivalent Approach when disclosing grades and other mining parameters. The drawback of a metal equivalent grade calculation is that it implies a constant relationship between metals, which is often not the case, but this approach is the most commonly used when assessing deposits with multiple elements.

Infrastructure

Projects with limited or no infrastructure generally require more funding. Infrastructure costs usually include the costs of building roads and/or railways and airstrips, installing sources of energy and water supply, building warehouses to store raw materials and costs associated with the development of separation and refining facilities, if not outsourced. Companies with vast infrastructure needs also tend to be further away from production, as they not only have to raise the funds, which could be delayed by poor market conditions, but if the project site is in a remote location and difficult to access, it would also likely limit the speed of the construction process.

Metallurgical Process

This is a major valuation factor. Rare earths are typically found in the company of other elements and metals and most commonly mined as co- or by-products; as such, extraction techniques vary. Since every deposit is unique, the concentration, separation and refining processes have to be assessed for economic viability and then reproduced in a large scale. The separation and refining of rare earth elements, in particular, has always been a major challenge. Extracting gold from ore, for example, is relatively easy. Mixing the gold ore with a cyanide solution is a common method of extracting gold. The separation of individual REE, on the other hand, is extremely complex and involves many steps because elements have similar chemical properties.

Environmental Impact

Rare earths are crucial for the development of green technologies but their mining has environmental issues. Rare earth deposits often contain radioactive materials, such as uranium and thorium, and, in such cases, the separation process results in radioactive tailings that could be expensive to safely store or dispose of (if the radioactive materials are not commercially extractable). Mines with high concentrations of radioactive elements may have difficulty obtaining the necessary environmental approvals or may be subjected to heavy regulations which can cause delays. Furthermore, the refining process often involves several acid-baths that also need to be safely disposed of. Thus, understanding the impact of the mining activities to local and surrounding environment is extremely important.

Timing

Projects that are feasible when markets are favourable may not be when demand and metal prices are low. Commodities usually follow cycles, and the possibility of a downturn should always be considered. China has started consolidating its rare earth industry, which may set a global trend, leaving small players that emerge later with limited growth possibilities.

Political Climate, Country Risk

Projects or mines in politically unstable countries could be disrupted by war, acts of terrorism, or violation and/or manipulation of contracts by local government. Politically unstable countries also tend to have highly volatile economic conditions, often with high inflation and unstable currencies. Higher discount rates are usually applied in the valuation of companies with high geopolitical risk, and macroeconomic data should be included in the forecast of the company‘s operations.

Vertical Integration

Companies that are capable of producing finished products could generate higher margins. The majority of value comes late in the value chain, thus the ability to process high-end products is a key value driver.

End-use Market

Rare earths constitute 16 distinct elements that are used in a variety of applications — they are used extensively in the renewable energy sector and in the automotive and defence industries with mostly different economic drivers. As China cuts exports, it is believed to be affecting the supply of all 16 elements; however, as the supply side stabilizes, greater attention will be paid to the demand side of the equation. Understanding which materials a company supplies, and the main market for its products, is of major importance.

Summary

A sound investment will include a company with an experienced management team, a project that has good infrastructure, has achieved significant milestones, has a good resource grade and material content, and has the ability to fund the project development until its online date.

Luisa Moreno, Ph.D, Analyst

Jacob Securities Inc.

www.jacobsecurities.com

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