Quest Rare Minerals of strategic and economic importance

The meteoric rise of Quest Rare Minerals (QRM-V) from a 5¢ stock in April 2009 to its current $5.35 price tag is capturing the attention of investors on both sides of the U.S.-Canada border and beyond.

In the first week of October the junior had no trouble raising $46.5 million in a new issue of units and flow-through common shares that will help it finance a prefeasibility and feasibility study on the Strange Lake B-Zone rare earth deposit in northeastern Quebec.

“It was very well received by U.S. institutional investors — we were oversubscribed by more than three and a half times relative to our minimum financing expectations,” Peter Cashin, Quest’s president and chief executive, said in an interview over lunch at Toronto’s Albany Club.

“I hate giving money back,” he joked.

The financing (by a syndicate of agents led by Dundee Securities and including CIBC World Markets, Euro Pacific Canada and Stonecap Securities) followed the completion in late September of a preliminary economic assessment (PEA) of the Strange Lake B-zone resource, which delivered numbers strong enough to suggest that the Canadian explorer can build a supply of world-class rare earth elements (REE) outside of China, which currently monopolizes global supply and processing.

Equally important is that an estimated 50% to 65% of Quest’s rare earth elements at Strange Lake are the more valuable heavy rare earth elements (HREE). In August 2009, China banned the export of five HREEs: dysprosium, terbium, thulium, lutetium and yttrium. The Strange Lake B-zone deposit contains all five of them. (In addition China has slashed export quotas by about 40% on other REEs during the last four years, according to figures provided by the company.)

“It’s been such an easy sell for me,” Cashin says. “The numbers are almost too good to be true. We can bring economic and strategic logic to this project.”

The final preliminary economic assessment showed positive cash-flow, a strong internal rate of return and net present value metrics at discount rates of up to 20% for a mining operation at the deposit, about 175 km northeast of Schefferville, Quebec and 125 km west of Vale‘s (VALE-N) Voisey’s Bay nickel-copper-cobalt mine in Labrador.

Wardrop Engineering’s study used a conventional truck and shovel open-pit mining operation at a production rate of 4,000 tonnes per day, using the 1.0% total rare earth oxide (TREO) cut-off used in the preliminary resource estimate released in April of 40.4 million tonnes grading 1.61% TREO, 2.07% zirconium oxide, 0.25% niobium oxide, and 0.053% hafnium oxide. Wardrop estimated a minimum mine life of 25 years.

The 4,000 tonne-per-day open-pit production schedule could be achieved from the middle of the second year of mine life, Quest says, and the PEA noted that total pre-tax cash flows over the life of the mine would fall in the range of $7.97 billion.

Total operating costs per tonne of ore milled were calculated at $102 per tonne and the project would have a payback of capital expenditure and a positive cash flow in the fourth year of operation. Other numbers included positive pre-tax cash flows of up to $368.2 million per year, an IRR of 36.4% and a pre-tax NPV of $1.41 billion at a 12% discount rate.

Wardrop estimates CAPEX of about $563.4 million to build the mine, mill/concentrator, site utilities and storage, a road and slurry pipeline to the coast of Labrador, tailings facilities and infrastructure development.

At full production the operation would produce annually more than 22,600 tonnes of TREO concentrate, more than 4,800 tonnes of niobium oxide concentrate, and nearly 40,200 tonnes of zirconium oxide concentrate. TREOs will make up about 58% of the mining operation’s revenues.

The deposit is close to surface with minimal overburden and is open in all directions and at depth.

Metal pricing used in the study was based on 2010 projections reported for a similar rare earth project and was validated using trailing three-year average pricing, which worked out to be about US$21.94 per kg. Cashin argues those figures would be much higher if more current prices for rare earths were used. “For example, if the three-year average price for TREO were used, we would yield a TREO price of US$36 per kg and increase the NPV by more than 50%,” he says.

“The investors’ strong demand supports the fact that the financial model estimates presented in the PEA are extremely conservative as they apply discounted, historical average metal pricing,” Cashin explains. “Project economics improve substantially if current TREO prices are used. We were being quite conservative.”

“We discounted the basket price by 39%, took a higher cut-off grade, used a lower mill recovery than is indicated in preliminary metallurgical work, and added a 25% contingency fee, and even after all of that, our cost per tonne was still just $102,” Cashin adds. “You can’t kill this project – even if you put a 25% surcharge on it.”

John Kaiser, a U.S.-based newsletter analyst who owns stock in the company praised the project’s fundamentals and its strategic importance given China’s current stranglehold on the supply of rare earths. “Unless it turns out that Wardrop is seriously misguided in its assessment of what it will cost to produce a mixed bulk concentrate at a mining rate of 4,000 tonnes per day, the Strange Lake rare earth project not only represents a major solution to the “Old World’s” security of supply problem, with capacity for extension of the mine life for another 50 years beyond what is currently envisioned, but also offers substantial speculative upside into the $10-20 range using fairly conservative future REO price assumptions and as high as $35-$60 using the more optimistic price set favored by JP Morgan in its Sept. 29 industry update, where it sets a US$1.71 price target for Lynas based on rare earth oxide prices not far from the current FOB spot prices,” Kaiser wrote in an Oct. 3 research note to clients. (Lynas Corp. (LYC-A) holds the Mount Weld rare earths project in Western Australia, about 35 km south of Laverton.)

According to Cashin, the gross in situ value of the Strange Lake B-zone deposit, using four-year averages, is about US$35 billion. “That would work out to about a 30 million oz. gold-equivalent deposit at a gold price north of US$1,000 per oz.,” he says.

The study also used an 80% metallurgical recovery rate, which Cashin argues is lower than current recoveries that fall in the mid-80% to low 90% range.

“What gets me excited is that it’s a 114-million-tonne resource down to 135 metres. All of our holes were stropped in mineralization between 70 and 135 metres below surface. Two hundred and fifty to three hundred metres seems to be the bottom of the mineralized system so we could easily double the resource.”

So far this year Quest has drilled an additional 81 holes (not included in the preliminary economic assessment). The majority of them were drilled in a high-grade pegmatite near surface. Of those holes, results from just 11 have been released so far and the company anticipates it can report 15-20 holes every couple of weeks from now until the first quarter of 2011. Heavy REE represent between 39% and 77% of the total REO content intersected in the latest drilling.

Exploration work has also traced surface minerals with good grades 5 km to the east. Quest has finished a 35-tonne bulk sample and sent it to a laboratory in the U.S. “We’re looking at a big structure with a huge surface footprint and no overburden,” Cashin notes.

The company is in discussions with industrial companies in Japan and Korea for potential future investment or joint ventures in the marketing and processing of REEs from the Strange Lake B-zone. “Usually the Japanese don’t look at anything less than a project with a completed prefeasibility,” Cashin says.

“We really didn’t do any promotion in the last twelve to fourteen months but it’s really taken off. If you d
o good technical work and show exploration success, the money will flow to companies that are building significant projects.”

Quest plans to update the resource to measured and indicated by the first quarter of 2011 and then input the new numbers into its preliminary economic assessment and make a decision about a prefeasibility and feasibility study.

The company also expects to complete pilot plant-scale metallurgical testing and prepare for environmental baseline preliminary engineering studies in 2011.

“We think we could start mining it by 2015,” Cashin forecasts.

He also explains that if all goes well, the mine will be built in Quebec and the concentrator would be set up on the coast of Labrador. The slurry would flow through a pipeline down a natural gradient from the mine to the concentrator. All further downstream processing would be done in eastern Canada and shipped to principal U.S. and world markets.

Strange Lake was first discovered by the Iron Ore Company of Canada in 1979, which took the project to the feasibility stage in 1985 with just two rare metals: zirconium and yttrium. There was no value attribution of rare earth elements at the time, Cashin explains, because their value was so low. And IOC didn’t differentiate between the importance of light rare earths and heavy rare earths, he adds.

A number of companies staked the land after IOC let its claims lapse, but only carried out “tabletop evaluations” of the property, Cashin says. “It wasn’t until we were walking on and breaking rocks on site that the thing came together,” he points out. “We determined that the HREE portion was high and that’s when the market took note.”

In addition to Strange Lake, Quest has discovered a second new area of rare earth element mineralization at its Misery Lake project, about 120 km to the south of the Strange Lake deposit.

At presstime Quest was trading at $5.35 per share. Over the last year the stock has moved between a low of $1.65 and a high of $5.57 per share.