Rare earth stocks present unique challenges for investors. Here are 8 rules to follow to cut your risk.

Rare earth stocks are shares of company 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.

Uses for rare earths include: 1) catalytic converters, 2) magnets in small and large motors, 3) glass additives and glass-polishing compounds, 4) rechargeable batteries and 5) TV and computer screens, lighting, x-ray machines and lasers.

Right now, China accounts for around 95% of global production of all rare earth stocks. Most of its output is from mines in Inner Mongolia. Rare earth stocks typically have very labour-intensive mining operations. These mines are best suited for countries with low wages and weaker environmental standards. That’s the main reason why significant new mines have not opened in other parts of the world. However, there are potentially mineable rare-earth deposits in Australia, Africa and North America.

These deposits could be brought into production if prices go high enough. The total global market for rare earth stocks is now around $3.5 billion U.S. per year. It could eventually go substantially higher, with the expansion of technology sales to an expanding middle class in emerging markets, but that could take years if not decades.

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8 ways to profit from rare earth stocks

1. To profit in rare earth stocks, you should look for well-financed companies with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests.
2. High-quality rare earth stocks should have strong balance sheets with low debt. Junior mines should have a major partner who can finance a mine to production.
3. 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.
4. Remember that it’s much easier to launch and promote one of these stocks than it is to build a profitable business. So junior mines attract more than their share of unscrupulous operators and stock promoters.
5. We generally stay away from 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. Rare earth 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.
6. We look at environmental constraints, too. In Australia, Canada and certain parts of the U.S, they need a particularly rich find to justify the costs of overcoming environmentalists’ objections. The rare earth refining process is quite toxic so you don’t see as much exploration and mining in countries with strict environmental laws.
7. When we recommend rare earth stocks, we prefer those that operate in an area with geology that is similar to that of nearby producing mines. Rare earth stocks that try exploring in unproven areas are more of a gamble.
8. Rare earth stocks will grow over the coming decade. The world’s demand for high-end rechargeable batteries is only going to get greater, and the rare earth refinement process will also become less toxic. This opens up opportunities to mine in more environmentally strict jurisdictions.

Are you invested in any rare earth stocks? Are you waiting on the sidelines to see if bigger mining companies start exploring rare earth metals? Share your experience with us in the comments.