Mickey Fulp: Bullish on Uranium and Rare Earths
Interview

The Energy Report: Mickey, do you see undervalued sectors that make you think, "Boy, the market just hasn't gotten this yet?"

Mickey Fulp: The only sector that I think is absolutely undervalued right now as a whole is uranium. It certainly has been beaten up since mid-2007.

TER: Are things improving, in your opinion?

MF: Absolutely not. Although I first started saying in January of '09 that the uranium sector was down and I expected uranium prices to rebound, they haven't done that. However, as opposed to last year, there is a lot of analyst consensus now that the uranium sector is undervalued. I've been bullish on uranium for quite a while based on supply/demand fundamentals and that bullishness still exists. So, from a contrarian point of view, I would say that most uranium stocks are undervalued right now and present buying opportunities.

TER: Some interesting agreements have been made surrounding the Washington Nuclear Security Summit regarding enriched uranium, specifically the agreement between the United States and Russia to disarm one-third of their nuclear arsenal. Ukraine has also agreed to dispose of their highly enriched uranium stockpile. Will these developments have a continued impact on uranium prices?

MF: I think that is unclear as of now. These highly enriched uranium agreements could certainly supplement supply but weapons-grade material has to be converted into low-enriched uranium for use in nuclear reactors. Highly enriched uranium used for nuclear weapons is about 85% U-235. The typical light-water reactor uses light enriched uranium that's typically 3% to 4% U-235. This could certainly overhang the market. The spot price is $42. Long-term is about $58. I don't think it's likely we will see major increases or decreases in these prices in the short to mid-term.

Certainly all the new mines coming onstream have increasing costs of production. There are very few new mines proposed or in development that are going to make money at a $40 spot price, but between 80% to 85% of the uranium yellowcake market is sold on long-term contracts. That's somewhere around $60 right now. The other thing to note is that fuel is only 10% of the cost of producing electricity in a nuclear power plant, which is very minor. We see sovereign nations, companies and utilities as some of the biggest buyers of uranium and often those sovereign entities are not concerned with the price.

In the uranium sector, supply security is the important thing. We do know that demand is increasing significantly year after year. Mine production is about two-thirds of the world's use. There are 59 new reactors in construction which will need initial startup feed. Utility companies that produce power through nuclear power plants historically have signed supply agreements for about three years. Those secure supplies right now are averaging about a year and a half. Based on that, I'm very bullish on the demand for uranium.

What we have to take into account is the geopolitical situation of uranium production. Forty-six percent of 2009 production came from countries that are not stable or very friendly to the western world. Most uranium is consumed by the West, especially the United States, which consumes about 30% of world production on a yearly basis, around 55 million pounds. Yet we produced less than four million pounds last year. So where does our uranium supply come from?

For the last few years, a significant amount has come from the Russian Megatons to Megawatts program; high-enriched uranium being reduced to low-enriched uranium. However, the number-one producer of uranium last year was the country of Kazakhstan, which is arguably one of the most corrupt regimes on the face of the planet. There were internal corruption issues in Kazakhstan last year with the government showing indications of increasing nationalization of its uranium industry. Nevertheless, production continued to increase significantly. The number-five mine producer last year was Russia, followed by Niger, which had a coup in February. There is every reason to think that a significant economic reason for the coup was that over 70% of Niger's exports are uranium. It supplies France with 40% of its uranium. The number-seven producer in the world is the country of Uzbekistan. Investing in the "Stans" is a huge geopolitical risk and has been since the Soviet Union dissolved in the early '90s.

TER: But is it an increased risk because they won't sell to the West, or because they may not produce uranium because of political and economic turmoil?

MF: I think it's combination of both. Kazakhstan has increased its uranium production astronomically just over the last three or four years. It has replaced Canada as the world's largest producer. Whether or not it can sustain that production remains debatable. As the shallow, easy-to-get, in-situ uranium is produced and depleted, it gets more difficult to go deeper and deeper. Not many people are aware of the fact that in-situ recovery uranium operations have very steep decline curves. In other words, you get the easily extractable uranium out first and then you have a continuing decay of production as the field matures. That happens very quickly. So in Kazakhstan, not only do you have geopolitical risk, but there's also the economic risk that they can't maintain their production. Certainly in Niger, I think it's strictly geopolitical risk. There are two big mines that produce there. AREVA (PAR:CEI) is the partner. There is a third huge mine coming onstream that will produce on the order of 11 million pounds a year, which would be about 7% of world production.

TER: Considering supply and demand and geopolitical issues, which of these undervalued uranium companies represents good future potential?

MF: I concentrate strictly in North America and I invest in companies that operate in past producing and/or currently producing districts. In the U.S., I like companies operating in Wyoming and New Mexico because that's where the majority of uranium has been produced in the past and where current resources are likely to be developed. My favorite company is Strathmore Minerals Corp. (TSX.V:STM;OTC.PK SHEETS:STHJF). They are in a bankable feasibility study at Roca Honda, New Mexico, which is arguably the best undeveloped underground uranium deposit in the United States. They are proceeding with mine permitting at Roca Honda and in the Gas Hills of Wyoming, where they have the commanding land position for conventional open pit uranium development. In addition they have another eight development projects. They had 10 a few months ago and they've monetized two of those.

The company has every intention of monetizing its other development properties in New Mexico and Wyoming. Strathmore has $29 million of working capital and is absolutely the most undervalued uranium developer on any North American exchange. With a market capitalization around $60 million, $29 million working capital and 125 million pounds of uranium resources, I think Strathmore is a no-brainer at $.70.

Another company I like is Hathor Exploration Ltd. (TSX.V:HAT). Hathor has had recent exploration success in their winter drilling program at Roughrider and Roughrider East in the northeastern Athabasca Basin. Their resources have grown significantly. Exploration potential continues to expand around the current plays. They have a couple of other projects that are very interesting as well, including the Russell Lake project next to Denison's Wheeler River discovery in the southeastern part of the Athabasca Basin. There is also a project called Henday, a joint venture with Forum Uranium Corp. (TSX.V:FDC) about 10 kilometers north of the Roughrider discovery. The drilling they did this winter was very encouraging, encountering strong clay alteration. They'll be drilling there again this summer. It's a company that I've been buying on weakness.

I pick away at these stocks on weakness. Although I may cover 8 or 10 companies at any one time, I'm probably invested in 15 to 25. The ones I publicly talk about are those that probably have the best chances of success. I consider my investment profile to be of much higher risk than most people are willing to take or should take as lay investors. With those that I talk about, I may be accumulating on weakness because they are longer-term plays for me and I see possibilities that they will build successful mines, ultimately sell out to other companies, or enter into strategic alliances. The bottom line is that over the mid- to longer-term they should reward shareholders.

TER: Are you still bullish on rare earth elements (REEs)? Do you still see potential upside or has the market priced that in?

MF: I'm still bullish on rare earths. I've said more than once recently that this is a very early stage of a bubble supported by the U.S. government. Policies are being implemented by the government with a bill in Congress likely establishing a rare earth element stockpile. There is increasing demand for these metals that are completely controlled mine-to-market by China. There is an awareness and a mine-to-market philosophy developing in the U.S. I continue to be bullish on the sector as a whole and think it's still very early on.

I've used an analogy in the past of a nine-inning baseball game. I think we're somewhere at the bottom of the second or the top of the third in the rare earth element bubble. So there are still opportunities in the sector. Many of these companies have taken off with valuations that have increased anywhere between two to over 50 fold over the course of a year, but I see additional upside.

Over the last two weeks or so there has been a significant market correction of most of the rare earth element players. This is very much a junior exploration sector play within a niche or specialty metals market. The sector has not attracted major mining companies. If you look at the recent market correction, and if you look at the charts, these junior companies are building strong charts. When they build strong charts like that you can see additional upside. So once again, I may go in and buy on weakness. I want to caution your readers: I was in very early in this play so my cost basis is much lower than current valuations. As you know, we all talk our own books and that's what I'm doing here. But I see potentially higher valuations in the offing.

TER: How many years do you think this nine-inning game will last, to use your analogy? Are we looking at a decade of upside potential in the rare earths, or one to two?

MF: I would say somewhere in between. For U.S. and Canadian producers to come online and for the mine-to-market capability to be developed in this sector, we are looking at about five-plus years. The big player in the U.S. is no doubt going to be privately-owned Molycorp, because at one time they had the world's largest mine. They still have the world's second-largest deposit. It should be back in production sometime in 2011 or 2012. Molycorp will be producing significant amounts of rare earths again and trying to develop downstream processing along with new technologies and products for end-users. Demand is increasing from phosphor and lighting, high-tech electronics, hybrid cars, and wind turbine energy. These metals are also crucial to national defense and security. I think there will be a significant time period before this bubble is ends, unless there is another world economic meltdown.

TER: Can Molycorp satisfy the mine-to-market needs of a country like the U.S.?

MF: I think that Molycorp will start up Mountain Pass soon. They're currently producing about 3,000 tons of rare earths a year from stockpiles. In a global market that produced 125,000-130,000 tons in the last year, it's currently a relatively small producer. The mine is projected to produce about 20,000 tons per year once it's fully operational. But we see year-over-year world growth in demand projected at 10% a year. Molycorp will not be able to supply all the needs of the United States. Furthermore, it's a light rare earth deposit. The heavy rare earths, although not a significant part of the total world tonnage, are very much a significant part in terms of value because they're very high-priced as well as being relatively rare. I personally see room in the sector in North America for additional light rare earth and heavy rare earth element mines. I picked companies that I consider to have the best prospects for

TER: Can you share those with us?

MF: I cover Avalon Rare Metals Inc. (TSX: AVL;OTCQX:AVARF), which had a new resource come out in the last couple of months and very good news on the metallurgical end. They are now proceeding to a pilot plant test and cost benefit analysis on the metallurgical process. We can expect a prefeasibility study in the next six to eight weeks on their Thor Lake deposit.

Another company I am bullish on is Rare Element Resources Ltd. (TSX.V:RES). They recently completed a big financing and have a working capital of about $12.5 million. A new resource estimate is expected soon and based on the drilling that they did last summer and fall, I would expect a significant increase in tonnage and also dollar value per ton. The drill results indicated strong values in neodymium, which is in very high demand in the magnet sector. The deposit is going to have a relatively high dollar value in the light rare earth sector. A prefeasibility study is expected in June. The other interesting note about Rare Element Resources is that it's really a two-for-one. There's a gold play adjacent to the rare earth element play in a joint venture with Newmont Mining Corp. (NYSE:NEM) and I think that Newmont will bow out within the next couple of months. So Rare Element will own 100% of the gold project and I expect a new round of drilling and then a significant 43-101 resource.

The other company I cover is Quest Rare Minerals, Ltd. (TSX.V:QRM) (formerly Quest Uranium Corp. (TSX.V:QUC), which recently announced a 43-101 qualified inferred resource, basically a geological mineral inventory, from their initial drill program late last summer and fall. They have a potentially huge resource at Strange Lake in far northeastern Quebec. Less than one-half is drilled where they know it occurs from mapping and sampling and it's completely open in all directions and at depth. All their shallow drill holes ended in mineralization.. They'll be back drilling in June and we expect the resource to grow significantly. It's a heavy rare earth element deposit.

TER: Is Quest diversifying beyond their uranium deposits and focusing on rare earths?

MF: Well, it was once a uranium-focused company. Quest was a spinout from Freewest Resources Canada Inc., which you may remember sold out to Cliffs Natural Resources (NYSE:CLF) for their chromite deposit a few months ago. Their uranium and rare earth element projects were spun out as Quest previously, and long before the REE sector started to heat up last year. Quest changed exploration emphasis to its rare earth element plays and it's paid off handsomely. A year ago it was a $.04 or $.05 stock. It's undergone a market correction in the last few days and is currently trading at about $3.25, off from a high of $4.18. It's in the process of changing its name to Quest Rare Minerals to reflect its role as a rare earth explorer. The uranium plays Quest had were not compelling to someone like me who likes to pick uranium companies in established districts of the Athabasca Basin or the western U.S.

TER: How can investors make unique plays in the rare earths sector?

MF: There are a few options. A company which I'm fond of and in which I've participated in private placements is Tasman Metals (TSX.V:TSM). It's run by a couple of really good Australian geologists that I met in Peru in the late ‘90s. They are focused on creating Scandinavian rare earth element plays and have acquired several advanced rare earth deposits in Finland, Sweden and Norway. They have announced initial drill results from Norra Karr and final results from winter drilling will be coming out soon. They've recently acquired the Bastnes deposit where rare earth elements were originally discovered in the early 1800s. We may see a number of additional acquisitions in Scandinavia. This gives investors a way to get a European REE play through the Toronto Venture Exchange. The European Union certainly will have demand for rare earth elements and this could be the company that supplies that demand.

Then there are a couple of other ways to play REEs. NEO Material Technologies (TSX:NEM) is a company which is a magnet powder, rare earth element alloy, and specialty metal producer in Toronto. It generates positive cash flow and could be a mine-to-market player or perhaps an acquisition target for someone (and I'm purely speculating here) like Molycorp, because they have current downstream product capabilities.

TER: How large is their project and when you say it's alloy what does that mean?

MF: They are a producer of rare earth element and rare metal alloys. An alloy is a combination of two or more metals. They're a downstream company with no exploration or mine projects. Perhaps they would be looking for an off-take agreement with someone who will become a miner. Perhaps they will become a takeover target of a larger company such as Molycorp, which needs to build downstream capabilities; or Lynas Corp. (AUS:LYC) of Australia which may want a presence in North America. These are pure speculations but NEO Material is a cash flow producing company on the downstream side of the rare earth element supply chain.

A company that gives you another way to play REEs is Dacha Capital Inc. (TSX.V:DAC; OTCQX:DCHAF).They intend to establish a rare earth element ETF, where they warehouse REE metals and compounds and buy and sell them. The company is fronted by Stan Bharti and his group and has increased its market cap by about 50% over the last month or so.

TER: What do you see in the green alternative energy space with uranium?

MF: I see uranium as a proven green technology which is established, economic, and expanding. Now certainly the solar and wind industries will contribute to the green energy agenda that governments are propagating to reduce carbon emissions. However, I do not follow any companies in the solar and wind arenas and there is a logical reason for that. Uranium has a long history of production and profitability. The kilowatt-hour unit cost from a uranium power plant is much cheaper than natural gas- or coal-powered plants. The solar and wind sectors are not economic without direct government subsidies. I am reluctant to invest in entrepreneurial, venture capital companies that depend on government subsidies and the current whims of elected government officials.

TER: Anything else you'd like to advise our readers?

MF: It's incumbent to do your own due diligence, because you and you alone are responsible for your investment decisions. Careful and diligent research will allow the lay investor to make better speculations in the high risk junior resource sector.

TER: Mickey, we appreciate your spending some time with us today.

The Mercenary Geologist, Michael S. "Mickey" Fulp is a Certified Professional Geologist with a bachelor's degree in Earth Sciences with honors from the University of Tulsa (1975), and a master's degree in Geology from the University of New Mexico (1982). He has over 30 years' experience as an exploration geologist searching for economic deposits of base and precious metals and other resources. Mickey has worked for junior explorers, major mining companies, private firms and investors as a consulting economic geologist for the past 22 years, specializing in geological mapping, property evaluation and business development. Respected throughout the mining and exploration community due to his ongoing work as an analyst, writer and speaker, Mickey launched MercenaryGeologist.com in late April 2008 and can be reached at [email protected].

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DISCLOSURE:
1) Karen Roche of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Avalon Rare Metals, Strathmore Minerals, Rare Element Resources.
3) Mickey Fulp: I personally and/or my family own shares of the following companies mentioned in this interview: Strathmore Minerals, Hathor Exploration, Forum Uranium, Avalon Rare Metals, Rare Element Resources, Quest Uranium, Tasman Metals, Neo-Material Technologies, Dacha Capital. I personally and/or my family are paid by the following companies: Strathmore Minerals, Avalon Rare Metals, and Quest Uranium are paying sponsors of my website. I have done consulting work for Strathmore Minerals.