When investing in rare earth metals, you need to look beyond just geological considerations to the unique geographical and political environment that the mining company works in.

For most investors, profiting from rare earth metals involves buying shares of companies that explore for, mine and refine rare-earth elements. Rare earth elements and minerals are a group of metals with unique characteristics. These include scandium, ytterbium, lanthium and samarium.

Rare earth elements go into a variety of modern devices and applications, including catalytic converters and petroleum refining; magnets in small and large motors; glass additives and glass polishing compounds; rechargeable batteries; television and computer screens; lighting; X-ray machines; and lasers.

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China, which produces an estimated 60% of the world’s rare earths, has previously stated that it plans to begin the shutdown of rare-earth smelters for failing to meet environmental standards such as those for water treatment.

China limits its rare-earth mining volume to a reported 120,000 tons a year. But an additional 50,000 to 60,000 tons appear to flow into the market from illegally mined sources. Smugglers use a range of methods, including injecting rare earths into pottery, which they then ship out of the country. The metals are later extracted when the pottery reaches its destination. However, once the government targets such mines, there is a possibility that about 60,000 tons of supply will be lost.

Demand remains especially strong for magnets from rare-earth metal. They’re used in motors for industrial robots as well as increasingly popular hybrid and electric vehicles. Electric vehicles require about 50% more rare-earth metals than gasoline-powered models.

Despite all these factors, it’s uncertain what the long-term outlook for prices will be. When prices rise, some users will move to substitute rare earths with cheaper materials. As well, if prices are high enough, rare-earth consumers will likely increase recycling, with metals firms reusing more lanthanum, dysprosium and other elements from industrial waste.

In addition, a sustained rise would make several closed mines and deposits in Australia and the U.S. once again economical.

Investing in rare earth metals through penny stocks can greatly expand your risk

In general, we avoid penny stocks that promote themselves too aggressively (or do so misleadingly). This includes rare earth pennies. Here are some other factors we consider when we analyze penny stocks for aggressive investors.

• We want to see experienced management with a proven ability to develop and finance a company.
• We look at environmental constraints when we consider mining penny stocks in particular. When we recommend junior stocks exploring for minerals, we prefer those that operate in an area whose geology is similar to that of nearby producing mines.
• We think you should avoid stocks that trade over the counter, where such things as regulatory reporting are lax.
• We also like to see a sound balance sheet in all the penny stocks we recommend. We like to see enough cash to keep operations going without the need for dilutive share issues at low prices.

More tips on finding mining-stock gems, including investing in rare earth metals

In mining exploration, an “anomaly” is a geological formation that might attract a prospector’s interest. However, one rule of thumb is that you have to look at 1,000 anomalies to find one prospect—and fewer than one prospect in a thousand turns into a mine. In other words, finding a mine is a million-to-one shot.

We generally stay away from pennies—including rare earth stocks—that operate in insecure and politically unstable regions such as Mongolia or Kyrgyzstan. We also avoid those in countries with little respect for property rights and the rule of law. Mining is particularly vulnerable to political instability. You can’t move the mine to another country, and local citizens may sometimes get the impression that a foreign mining company is robbing them of their birthright, even though the foreign company’s capital and expertise would appear to be the best way to get any value out of the ground.

Some of the best metal mining stocks come from companies that have been producing for years. For the mining component of the resources segment of your portfolio, the focus should be on firms with positive cash flow and high-quality reserves. Resource stocks overall (and this includes metals, of course) should make up only a reasonable portion of a Successful Investor portfolio.

“Majors” are typically mining companies that have been in the mining business for many years, and more often than not they operate producing mines on a global scale. Successful majors have proven methods for exploration and mining, and have consistent output and cash flow, year over year. On the other hand, “juniors” typically have negative cash flow since they’re spending money in hopes of finding a mineable deposit.

When we recommend top metal stocks, we want to see positive cash flow, preferably even when commodity prices are low. Even better, we like to see mining companies that have cash flow from an existing mine that is sufficient to cover, or at least contribute to, the cost of developing a second mine.

Use our three-part Successful Investor approach to help you build a sound portfolio

1. Invest mainly in well-established, mostly dividend-paying companies
2. Spread your money out across most if not all of the five main economic sectors
3. Downplay or avoid stocks in the broker/media limelight

There is real doubt over how rare the so-called “rare earth metals” are. The United States Geological Survey actually considers these elements “moderately abundant.” Still, how much will EV demand drive up prices?

This post was originally published in March 2022 and is regularly updated.