The role of a financial advisor has become increasingly important throughout this pandemic as both firms and individuals are seeking guidance on how to stay afloat during the current economic shift. Penney described these times as the “Superbowl” for financial advisors and that, so long as they overcommunicate and focus on digital marketing strategies, they should manage to prevail.
Ryan: Welcome to Non-Beta Alpha. I’m Ryan Morfin. On today’s episode we have Shirl Penney, founder and CEO of Dynasty Financial Partners. Dynasty’s our A aggregator and service provider in the independent RA channel, and today he’s going to talk to us a little bit about the wealth management industry and the trends to follow in 2020. This is Non-Beta Alpha.
Shirl, thanks for joining us today on the show. We appreciate you coming on.
Shirl Penney: Thanks for having me, Ryan. It’s great to be here.
Ryan: Well, we appreciate your leadership and insight in the industry. The breakaway brokers have continued to look for independence during this economic reset if you will. I was wondering if you could maybe go into a little bit about where the wealth management industry in the RA space was prior to the exogenous shock of coronavirus. And then maybe we can go into where we see it going in the future.
Shirl Penney: Sure, I’m happy to. And again, thanks for having me on. I think sometimes when you have a shock to the system it really accelerates a lot of the trends that were already starting to building before that shock occurred. So some of the trends that we were seeing within the wealth management space would be around technology and deploying technology throughout your business. A dynasty had started to really incorporate a lot more video interaction, Zoom technology, into how we were servicing our clients, being advisors, RAs, independent advisors, and encouraging them to utilize that same technology in how they interacted with their clients. We also had started a whole process of tech enabling all aspects of their business, whether it’s systematizing how they built their investment models, trading programs, how you could make compliance more automated, et cetera. So, really embracing technology across their business and how they interacted with their clients through digital, really cyborging their business if you will, taking all the great aspects of judgment, right, that a human advisor can bring to the table, but utilizing technology to scale that type of connectivity with their clients across a larger growing book of clients. So obviously, we’ve seen technology play a big part in the industry, covering our clients over the past multiple weeks and months. But that had started, and is now accelerated.
Also, Ryan, as you know, we have seen a lot of consolidation. And I think what you’re going to find is an acceleration around consolidation. Scale mattered before this crisis; it’s going to matter even more after this crisis, whether that’s service providers, custodians, independent broker dealers, asset managers, wealth advisors, RAs. I think you’re going to see more consolidation on a go forward basis. It really started to accelerate as we headed into the beginning of this year, and I think you’re going to see the back part of this year, 2020, really spring-loaded with a lot of M&A transactions that maybe had started and then stopped, that now advisors might think “Maybe I missed an opportunity to sell prior to this, let me jump back in.” And those really well-run firms who have been prudent with their capital, they’ve been disciplined with their capital, I think are going to really win on a disproportionate basis in the coming months.
And then the third trend I guess that I would highlight, which you touched upon, is this move towards independence, the whole independent movement, where we used to say it’s a trend really; now it’s the movement. I agree with what you said at the onset, you’re going to see an acceleration. I think it’s for a whole host of reasons. But complacency has really been a big competitor of those of us that are on the independent side of the industry over the last 11 years as we’ve been in a bull market.
But I think now advisors are taking a half step back and saying, “Okay, where do I want to be for the next three, five years, ten years of my career? Where do I want to continue to build my business?” And if I’m in an environment where I’m working for an organization that’s maybe looking to cut costs, which means cut resources, under invest in technology, et cetera, maybe I used to think that real estate was a big part of the value prop that I got for the 50%, 55% of revenue that I was giving back to the home office. But now maybe real estate isn’t as important to my business going forward. And if my revenue is off because the market has pulled back and maybe revenue levels stay off for a period of time, maybe I’m going to look to the independent space where I can keep a larger percentage of the revenue that I produce.
So I think all three of those trends, whether it’s technology, consolidation, movement to independence, they were all there prior to the last couple of months, but I think you’re going to see a pretty significant acceleration of those in the coming months as well.
Ryan: And we just Deal Price this week, Buckingham made an announcement, they acquired another practice, a $450 million RA. Do you think the valuations are going to change, or the deal structures are going to change now that we’ve had this reset, and asset levels and revenue based off of that?
Shirl Penney: Well, I would venture to say they are going to change somewhat. But depending upon where your business sits in terms of size, growth, profitability, I think you’re probably not going to see, Ryan, a lot of change with those five billion plus type business, those enterprise type clients as we call them here at Dynasty. Those multiples, we’ve seen certainly be in the double digits. I don’t think you’re going to see a lot of pullback there. If they’re run well, they’re growing, they’re annuitized in terms of the revenue, I don’t think you’re going to see much change there.
I think in the middle market space, those practices that are, let’s call it 500 million of assets under management up to a couple billion, you might see a little bit, it may be a turn or so. But I think where you’re going to see some of the adjustment is in more of the lifestyle business. I think you’re going to find a lot of the advisors that maybe just a couple months ago were holding on for a higher price, or thought that maybe their business was worth more than what the market was willing to pay at the time, we’re already seeing instances where those advisors are calling us and saying, “Hey look, can you introduce us to one of the 45 firms that Dynasty is powering?” They know we have a lot of capital to deploy behind those firms. And they’re just worried that maybe this could go on for a while and they’ve missed their opportunity to transaction. And I think that is probably going to cause somewhat of a readjustment in valuations and will probably spike the number of deals done into the fourth quarter 2020, first quarter of 2021.
Ryan: That’s great insights. I would say that as you’re recruiting folks out from the wire houses, I think you mentioned this as well, do you want to go to an organization that is in growth mode, or are they cutting expenses for financial gain, from a financial and generic standpoint? How do you address or how do you highlight the reps who are maybe shopping different homes, the importance of going to a platform that has low level, maybe that’s not private equity owned, that is on safe financial footing? What is the conversation with reps that you talk to on that topic?
Shirl Penney: Yeah. Well first of all I would say it’s an educational process. And I would encourage any advisor that’s contemplating a move or contemplating taking on any type of capital partner to really start early in doing the due diligence and learning the language. It’s a little bit like going onto the field of battle against our elite Navy Seals and you’re out there learning how to put the gun together and shoot it, on the field of battle. Well you obviously stand no chance. So if you’re going to go and have conversations with private equity, with professional buyers who do this for a living, then you really have to start early and get educated to understand the language, that maybe it’s not one that you use every day as a financial advisor. If you don’t Prefequity or Picks in terms of how they work, if you don’t understand different share classes, et cetera, then you probably shouldn’t be out there negotiating with people who do that for a living.
So, start early. Get yourself maybe a high-quality CPA, attorney, a consultant. There’s various players in the space that can help you. And really understand all the various constituencies that are coming to the table around your business.
So, if you’re an advisor working at a wire house, which many of them obviously large public companies, the management has responsibility to the board of directors, who have responsibility to the investors. That may not always align with what’s in the best interest of the advisor, and may not always align with what’s in the best interest of the underlying client.
So, one of the things that we hear from advisors that really like being on the independent side of the industry, is they have the ability to work for themself, to really customize the client experience and how they want to build that out for their client and really be a true fiduciary where they can align the success of their business around the success of taking good care of their underlying clients.
When you introduce private equity into the equation, if it’s a fund obviously the management team at the fund has a responsibility to return a reasonable investment to the investors that are in the fund. There’s nothing wrong with that, it’s just a function of making sure if you’re an advisor that you understand where there could be conflicts or where maybe that doesn’t necessarily line up with what your goals and objectives might be in any given timeframe.
I think where the challenges occur is when people just aren’t investing the time to get educated. They’re getting surprised, or their clients are getting surprised. And no one likes to be surprised, especially in business partnerships. And I find, Ryan, if people are starting early, getting educated, talking to their peers, really doing the due diligence, there’s so many different ways now with podcasts and whitepapers, I mean there’s really no excuse for any advisor not to put in the work. It’s their life’s work to put in the work to get educated in advance of those types of conversations and ultimately decisions on how they might want to take on capital partnerships.
Ryan: And as they’re going out and obtaining these consultants or advisors or law firms, sometimes there’s additional conflicts of interest with those relationships as well. Maybe you can go into that.
Shirl Penney: Well, I think you want to ask a lot of questions. I mean anyone that you’re working with you should always ask, how do get paid? Very specifically, how much are you getting paid and by whom? If you’re working with a consultant, if you’re working with a banker, if you’re working with a recruiter, just make sure you understand when they’re making a recommendation, how they’re being compensated. Are you paying them strictly for their time and for their guidance? Are there other ways that they’re getting compensated? Again, there’s nothing wrong with that either, it’s just about transparency and making sure that you understand how someone is being compensated. Because sometimes it can influence behavior.
I think most people, and I think you’d agree with this, Ryan, most people that are in our industry are good people and they really are in this business because they want to help people. But I think we should always understand all the dynamics. And again, if you’re moving into a new space that you haven’t grown up in, it’s a bit of a different language, the more questions that you can ask to understand the alignment that might be out there, the better off ultimately you’re going to be to make the right decision for you, your business, your family, your colleagues, and most importantly your clients.
Ryan: So, the industry’s been going through a consolidation, not only at the RA level, the broker dealer level, but also at the custodian level. And maybe you can talk a little bit about your thoughts about this race to zero fees, and how does make sense as a business model from an advisor’s perspective?
Shirl Penney: Well, first of all, from the service provider’s perspective, I mean obviously there’s other ways, although it’s getting more difficult in a rate environment that we’re in now, for a custodian making a lot of the economics typically on spreads on cash, some product-related fees and credit, spreads that could be there on margin lending, et cetera. But I think the challenge is that the custodians and some of the service providers are going to have, is the need to innovate, to add more value to their clients, whether it’s to the advisor if you’re B to B, or the end consumer if you’re B to C, making sure that you’re continuing to add value in ways that your respective clients are willing to pay.
Specific to the advisory business, I think you’ve seen a pretty rapid deterioration of the commission-based business anyhow, and a move towards more of a professional asset management approach and then wealth management approach. And now you’re seeing a lot of other ancillary businesses. A lot of the firms that we serve have family office businesses, they have project management fees for clients that want to buy a vineyard, want to sell a business, whatever it might be, they’re charging advisory fees on the credit side or the liability side of the balance sheet, not just on the asset side.
So I think it’s really important that advisors, if you’re thinking through that five-year plan and you’re building your economic model, is that you’re thinking through alternative ways to add value to your clients in a way that they’re going to see the value and be willing to pay for it. Because we are having reasonable margin compression across the industry. But what I think is really interesting about it, if you peel the onion back a bit… And when we started Dynasty nine years ago, the average end client that an advisor was covering was about 5 million dollars, so nice high net worth client focus that we continue to have, the ROA for that client nine years ago was about 77 base points. Today it’s about 73. So you haven’t seen significant deterioration on the revenue side.
But what’s interesting is the expectation of that client in terms of the services that they expect has just about doubled. They want financial planning, they want a liability side of the balance sheet, they want more robust reporting technology to maybe look at some of their liquid assets, whatever it might be. So the cost side and what has caused some of the margin compression has been a little bit on the revenue side, but even more on the cost side.
Which gets back to what we talked about earlier, the ability to tech enable or firm, thinking through outsourcing non-core things. One of the biggest mistakes that we see, a lot of RIAs that come to us looking to outsource that they’ve made, is they’ve insourced things that are not their secret sauce. It’s not what differentiates them. They’ve over-hired. The biggest line item from a cost perspective for any of these RIAs most typically is their staff. And the vast majority of these billion to five billion type RIAs are overstaffed.
And I think one of the trends that you’re going to see evolving in an accelerated way for already independent RIAs is a real push to outsourcing, right. Really sitting down and analyzing their business. Because we’ve been in this 11-year bull market where maybe we haven’t been as disciplined as perhaps we should on the cost side, and now if revenues are going to be off and clients are playing even closer attention to fees they’re paying, right, because their returns have been impacted, all of that I think is going to add up to the CEOs of these advisory firms saying, “Okay, what is it that really defines us? How do we invest there?” And then the things that are more commoditized, the things that are in that middle and back office, that maybe we don’t have to do here, how can I outsource that to my broker dealer? How can I push that maybe to the RIA custodian? How can I push those to an integrated platform service provider like Dynasty so I can get synthetic scale, and also have more variability in my cost structure?
One of the things that we’re hearing from our current clients, while it’s not necessarily great for us it’s good for them, where they’re saying, look, thankfully we outsourced our operations to you a year, or we outsourced compliance or marketing, because if I had chief marketing office or if I had a full time CFO or if I had a full time trader on staff, those fixed costs are fixed. And if your revenues are off 15, 20% quarter over quarter, right, you have more margin compression because you’re still paying that person. If you’re outsourcing to a firm like Dynasty and you’re paying either percentage of revenue or basis points on assets, now it’s a variable, right. So the cost of those functions within your firm actually moves down in an environment like this, which gives you more flexibility.
So, I think you’re going to see a lot more outgoing and leveraging of your resource partners like your broker dealer, like your custodian and platform providers, like us in the coming months, as more RIAs are forced into professionalizing their business. Which ultimately will be good for them because they’ll be running more profitable, higher margin, and ultimately building more valuable businesses.
Ryan: There’s been a bit of a strategic dissonance from the wire houses in the last six months. Goldman Sachs bought United Capital for a peak of the market price. Maybe putting in conflict the private bank with the United Capital advisors. Morgan Stanley just did the opposite, they bought E*TRADE, and now the private bankers are going to need to consider what that competition looks like. Is there a message that wire house advisors need to take away from some of these pivotal investments are redefining the wealth management landscape?
Shirl Penney: Well look, again you get back to the conversation around what’s the constituents that you’re really serving? And if you think about from a shareholder perspective, and you’re working at a wire house, I think all roads lead to retail, and controlling of those retail clients. And what I mean by that, Morgan Stanley does a deal with E*TRADE, which I do think is a smart transaction for them, in particular because you’re taking two of the largest stock playing franchises and now combining them. But the question then is who gets all the leads from stock playing? Is it employees, relationship managers working for the firm who get a salary and bonus and have very clear contracts that state that those leads that are coming into the stock plan are in fact and owned by the firm and not by the advisor. I would expect that you’ll continue to see more of that.
Well guess what, that’s more profitable for the organization. It’s also stickier for the organization. If you look at the margins on Merrill Edge and you see how profitable and such incredible success that that program has been at Merrill, that’s a direct-to-consumer relationship with the relationship managers that are there, and it’s a very different dynamic obviously between those relationship managers and the client than what a [Peabig 00:22:59] advisor in the private wealth group at Merrill might have that might consider leaving and then taking those clients with them.
So I think you’re seeing a movement, and advisors obviously are noticing it, to further institutionalize the client relationship and make the advisor/client relationship less important. That’s clearly not the script that they’re necessarily going to be talking, but that’s the reality of what you’re seeing.
And then from a client perspective, once that relationship really is with the brand and not the individual, then they’re in a position to be cross-sold more easily, whether it’s credit product, whether it’s capital markets, structured products, alternative investments, et cetera. Maybe checking products, more traditional banking products.
And again, it’s not wrong from the shareholder perspective. It’s only wrong if you don’t understand it and you don’t agree with it and then you don’t take action, if you’re an advisor, on behalf of your clients.
Ryan: And do you think there’s going to be a, as Wall Street starts to go down into Main Street, a branding issue for the United Capital, Goldman private bank branding confusion that may exist in the future?
Shirl Penney: Well look, I think a lot of these firms, Goldman included, are run by very intelligent people. They’re looking at the same data that we’re all looking at, which is undeniable, Ryan, in terms of all roads leading to the independent space. It’s the only part of the industry that’s growing in terms of advisor headcount, that’s growing by how we all keep score, which is assets. If you look at some of the RIA custodians have added more assets in the last 10 to 15 years than the entire private client division at these wire houses that took decades and decades to building, right. It’s a massive migration, which is both advisors moving to the channel and taking their clients with them, but what I think is even perhaps more important is the breakaway client movement, right. Client saying, “I want to get my advice separate from where products are manufactured and sold.” And you look at the organic growth of the independent advisor space, the adding of new clients, and it’s massive.
So you look at that data, and if you’re a firm like Goldman, you look at it and say, “Okay, if I’m going to be in the wealth management space, how do I get a foothold into the independent wealth management space? And how do I then acquire a firm that has a national footprint run by some principals who understand the space very well?” And then from that perch you can then assess how far in the water you want to go. You can stay with the advisory piece and then drive M&A through there. You can make decisions about do I want to become a custodian. They’ve been providing product and services into the channel now for quite some time. Does this help them accelerate into the channel?
I mean I know that you have a number of asset managers that listen to your show. Ryan, if I’m an asset manager right now, I need to be thinking, “What’s my independent wealth management strategy?” It’s not 20 years ago where you go to the top of the house, add a bank or a wire house, you negotiate a deal with your investment team, and then it would be driven top down into the branches. The independent space is very different, as you well know. It’s much more fragmented. It takes a very different approach, and a different strategy.
And I think the asset management firms that we’re working with, that we’re seeing do very well in the independent space, have said, “Okay, how can I be a value added service provider above and beyond maybe just the asset management piece?” And you have to do that well, but can I add business services, can I provide leverage with practice management, can I help provide marketing support? How do I take all the capability of the broader organization behind me and then deliver it to the independent broker dealer or deliver it to the RIA? I think the firms on the asset managers side that are doing that really well are winning again disproportionately in the independent space, and I think you will continue to see… You mentioned Goldman, United Capital, I think you’re going to continue to see a lot of the banks, brokerages, the wire houses, et cetera, continue to think through “What is my independent strategy? What is my RIA strategy?”
You’re seeing corporate RIAs getting formed now on a more accelerated basis with independent broker dealers, who are sitting there and saying, okay how do I create an environment, if I’m a large scale independent broker dealer, that allows my advisor to graduate onto a platform that we can create here, versus graduating off? I don’t want to hear that my largest, most sophisticated advisors have outgrown my platform, right. I want to know that I essentially have a division that they can graduate onto.
And we’re starting to get calls at Dynasty where independent broker dealers are saying, “Hey look, can you help us build a private wealth management division?” It’s really what the wire houses did 10, 15 years ago, building a firm within a firm, a dedicated private wealth division that their large advisors could join, they could recruit into, so it was a good offense and defensive strategy.
I think you’re going to start to see more people, more large scale players in the IBD space execute that strategy. And I think the result of that will be more growth for those firms, and it’s only going to further pour the gas on the proverbial fire to get more of the advisors in the wire house to go independent. Which is going to cause more attention for those firms to look at the space. Which is why I think we’re headed towards this place where the RIA space, independent broker dealer and the wire houses are all slowly converging into these large scale providers that will have a feeling more around separation from advice, from product manufacturing.
And I am optimistic that consumers will win. Advisors that get in front of it will win as well. But there’s still plenty of margin in it I think for other service providers, asset managers, et cetera, to do well as long as they’re in front of some of these trends.
Ryan: And you’ve been through a few cycles. What are your thoughts on the market today? Is it detached from the economy? Or how do you make sense of where the market levels are today, given the economic backdrop of the economy?
Shirl Penney: I do think it’s detached. And what we’re telling a lot of the advisors that we’re servicing is to really focus on mental toughness and to expect that things are going to get worse and perhaps much worse before they get better. Similar to, whether it’s a musician or an athlete, going out before a performance you want to envision all the potential different outcomes so that you’re more in the moment and calm and being able to react.
And I think it’s fascinating as a country, Ryan, to watch … And I know that you follow politics quite a bit as well, but to watch how we weigh the need for a compassionate democracy with a pragmatic democracy. And how some people feel like it’s either/or. I’d like to think that there’s room for both, that we can protect those that are vulnerable right now, without necessarily overreacting and have the cure ultimately end up, as we look back and say it was worse than the disease.
And I just think that the pendulum sometimes swings too far to each side. And there is definitely a leadership gap in this country, perhaps in this world, in this industry, where we just need to get people together, have a thoughtful dialogue, listen and understand people’s perspectives, meet people where they are without knowing the answer to the question before you listen to how someone else feels, before you determine what the right answer is to be more inclusive.
I am optimistic but I do think, again back to your question, there’s a disconnect around addressing how you put those two things together. There’s a disconnect with where the equity market is relative to how we’re probably going to see things play out in the credit arena, whether it’s credit cards that are about to go unpaid, the downstream ramification on the real estate side, looking at commercial real estate. Obviously large tenant restaurants, you’re going to see some horrific numbers I think in some of the large cities, maybe up to half of the restaurants not reopening. There’s obviously some very well-known companies that you can co-rent space from, without saying the name, that’s challenged in this environment, that could ultimately put more supply on the market. You have companies realizing that maybe I don’t need as many employees and maybe it’s okay to work remotely. And this is the new normal. We’re not going to go back to traditional office environments. Maybe I don’t need as much commercial real estate.
What is the ramification then? Ultimately, when landlords are not getting paid rent, there’s a supply and demand imbalance, that is going to find its way to the banks. And we just don’t know yet what these ramifications are going to look like over the next two, three, four quarters.
I also don’t think that we fully appreciate the long-term impact on our currency. When you look at some of the borrowing and obviously the stimulus program, which is unprecedented, and I’m not suggesting that it’s needed right now, but as we think through what the impact is going to be on our currency over the long-term, I mean there is definitely a series of challenges that are coming down the pipe. And I just think as leaders we have to try to be mindful of seeing the forest through the trees, and really being prepared for an environment that’s probably going to get much worse for an extended period of time before it gets better.
Ryan: And real quick, what are some of your best advisors doing and how are they reacting to either drive growth or keep clients bought into the game plan that they designed prior to the shock?
Shirl Penney: It’s really about over-communication right now. Clients want constant contact. And clients receive information in a whole host of different ways. I could tell advisors, “This is your Super Bowl. This is the advisors Super Bowl.” So you need to have a digital marketing strategy. There’s never been, for most advisors frankly, a better business development opportunity in their career than right now. Everyone’s listening. It’s why ads are so valuable during the Super Bowl, is because it’s one of the few times when everyone actually wants to watch an ad. Well, everyone wants to talk to a financial advisor right now. So you have to be proactive. Whether it’s writing thought leadership pieces, getting out on social media, which huge advantage. Obviously for independent advisors have more flexibility in that regard.
Making sure that you’re embracing video. We did a cooking event with an Iron Chef and opened it up for advisors to invite their clients. We had almost 2000 people attend this event, where they got a recipe in advance, they could bring their family together in the kitchen, ask questions of the Iron Chef and cook a dish.
So, we’re seeing advisors use more creativity with technology to connect in more meaningful ways with their clients. And I think again, the firms that have that digital client experience, that have a great web presence, that have been investing in search optimization technology, that have been investing in digital client on-boarding, electronic signatures, that have invested in their operations from a tech perspective, maybe using unified managed accounts, UMAs, to more efficiently run those portfolios. All of those things as you know, Ryan, end up saving an advisor time, which then allows them to have more time to take care of their clients in this environment and go get new ones.
And I like to say that this is a really, really good time for great advisors. And I’ve never been more excited for what we do at Dynasty in serving great advisors than we are right now.
Ryan: So, last question. What are some of the silver linings in the US economy for the next three to five years? And what books are you reading to keep your leadership or your mental curiosity going?
Shirl Penney: Well, I will tell you that I’m working more now over the last couple months. I was working a lot before, but I’m working even harder now. So, not having a lot of down time to do a lot of reading, other than I’ll tell you I’ve been really busy with, we have a CEO exchange, all the CEOs of the firms that we partner with. There’s been some incredible dialogue there around best practices, how to lead in chaotic times, best practices around client experience, et cetera. And what we’re finding is even the very best, these multi-billion-dollar independent firm CEOs have been very successful, they want to be independent but not alone. It’s so important to have a peer set.
I’m a fellow at the Aspen Institute, so it’s been great to spend time with some of the other leaders who are also fellows at the Aspen Institute, to hear in different businesses, not just in finance, what the impact has been.
But I think one of the things where we’ve had a little bit of extra time where it’s been incredibly meaningful to our employees and fed the soul, if you will, is the work that we’re doing in the charitable arena. We’ve done a lot locally in St. Pete, we’ve done a lot in New York where obviously it’s been felt disproportionately over the last couple of weeks and months. We’ve donated a lot of masks and personal protection devices, a lot of food to first responders. People don’t realize where all across this country with the schools being shut down, there’s so many children and families that have food insecurities, that have been significantly impacted, where for that child the best meal that they might have of the day was at school, right. Now they’re not getting that. So we’ve been doing a lot to rally our community around making donations to food banks, where we have various client offices. And just jumping in and helping to contribute around those issues has been really re-energizing to the team, which has then fueled us obviously to do our day job, and that’s to take care of our clients.
Ryan: Well Shirl, I appreciate you sharing your insights and your leadership for the space, and would love to have you come back in a few months and chat about how the economy’s either surprising on the upside, or stagnating. So, we appreciate you joining us today. Thank you so much.
Shirl Penney: Thanks so much, Ryan. Have a good day now. Bye-bye.
Ryan: See you soon.
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Pini Althaus: Thank you for having me, Ryan. Good to be here.
Ryan Morfin: So you're an investor and a miner in rare earth minerals. Can you share with our listener base, what are rare earth minerals? Why are they important and why is there a geopolitical race going on globally?
Pini Althaus: Yeah, I mean, rare earths are an extremely ubiquitous part of all advanced manufacturing or technology manufacturing today's day and age. Several years ago, I had not heard too much about rare earths myself. I was not that familiar with it and being involved in this sector, in this company, for the past few years has given me an education of course. And I mean, I was sad to hear that 50% of all imports into the United States contain are earth elements and it runs the gamut from consumer electronic devices that we use every day. Our cell phones, our laptops, most communication devices, medical equipment. So there's a tie with COVID, which we can touch on at your discretion. Electric vehicles, defense equipment. So pretty much anything or everything high tech today has a rare earth element or critical minerals contained within them.
Ryan Morfin: And what are some of the names of some of the more important rare earth? I know there's lithium for batteries, but what else is considered in this category, critical?
Pini Althaus: Yeah, so lithium is a separate category to battery material. The rare earths are 17 rare earths. The four, let's call it, key rare earths that we're focused on at our company, the four rare earths that go into the permanent magnets. And these are the magnets that are found, there are a number of them in your back of your cell phone or an iPad. But if you look at an F35 striker jet, you've got about a ton of rare earth magnets in those. And we've got two heavy rare earths and two light rare earths is part of the permanent magnets. You've got dysprosium, ytterbium are the heavies, and then you've got neodymium, praseodymium as the two light rare earths. So those would be key rare earths that are the focus.
Ryan Morfin: And you use these in, I guess, in military applications as well, but historically, where has the United States sourced the rare earth for supply chain?
Pini Althaus: Yeah. And that's the shocking part. We've been securing those materials from China. So China controls the rare earth sector and has done so for the past 30 years or so. And it was a significant misstep on the part of the United States, allowing China to have this control. And actually this wasn't a question of China coming in and doing anything nefarious as far as stealing IP or anything. The US government made a conscious decision about 30 years ago to allow China to come to the United States and acquire the processing capabilities for rare earths. So just as part of some background, you've got the rare earth materials containing various mining projects, but once you extract them, you have to then process them and they go through certain phases before they get to the magnet phase. And China, the thought process was let China do the mining, let China do the processing.
Pini Althaus: We don't need to do that here. And we'll buy the materials from China cheaply and the premier of China at the time, Deng Xiaoping made the comment, he said, "The Middle East has oil. China has rare earths." And unfortunately we weren't smart enough to understand what he was saying. And the Chinese understood that the future of manufacturing is going to revolve around control of the rare earth and critical mineral supply chain. So if you think about it today, Ryan, we cannot build... Forget about consumer electronics and medical equipment. We cannot build the equipment that the US Pentagon or the US armed forces require, whether it's F35 fighter jet, Tomahawk cruise missile, communications equipment, without going to China and obtaining those materials. And it's obvious to all that this should be extremely alarming. We've seen China use this as a weapon, if you will, as far as how it interacts with other countries back in 2010, when there was a dispute between China and Japan on the East China Sea.
Pini Althaus: So China cut off rare earth exports from Japan for 40 days. Japan obviously being a significant user of rare earth elements for their high-tech manufacturing sector, that was stopped after 40 days. But in fact, it was President Obama that first made the United States aware of this, formed a division within the Department of Defense to handle this issue, but not much has happened. And we continue to be relying on China for these materials. And what has been made about trade war with China and whether the trade war is really the impetus for China withholding rare earth exports. And that is a huge misnomer. Whilst China had been talking or implying that they would cut off rare earth exports, the truth of the matter is that China, under it's made in China, 2025 mandate, its belt and road initiatives and others. And you seem to control the critical minerals and rare earth supply chain so that it can continue its dominance as a manufacturer or a global supplier of these materials and finished products.
Pini Althaus: It's the backbone of its economy. And in fact, China has become a net importer of rare earths from different countries like Miramar and others. So with that, they are decreasing the exports to countries like the United States, Japan and others.
Ryan Morfin: And was it ever a risk that the Chinese were going to turn off the exports of rare earth to the US during the trade war? How close were we to that? And was that ever some saber rattling that went down during trade negotiations?
Pini Althaus: Yeah, I think it was saber rattling. I think it would be paramount to an act of war. I can't say with any authority that that would not happen, but it would be probably, aside from war itself, it would be one of the most significant acts of war cutting the United States off from the ability to procure rare earths. But that being said, I mean, if you look at, as an analogy, the oil and gas sector and the reliance of the United States had for many, many years on OPEC countries to supply us with the oil. And we had embargoes and we had price manipulation by OPEC. This is far more significant given the ubiquity of where these rare earths go. And yes, we're always under the threat that China can cut off exports under the guise of a trade war or for any other nefarious reasons.
Pini Althaus: But I think even more importantly, to just as the natural run of the course of things with regards to their business and their desire to maintain themselves as the global leader in manufacturing and exporting of goods, China is in a position now where it actually requires these materials for their own domestic consumption and can legitimately cut off rare earth exports by stating that they need it for manufacturing and that would actually be somewhat correct. So we're in an extremely dangerous position here with this reliance on China. And it wouldn't just be China. If it was another country, it would be similar issues, not to the same extent, but reliance on one country for these materials is dangerous.
Ryan Morfin: And it's been mentioned in the past that in 2010, China flooded the market to really kill all the competitors in the rare earth mining industry. Where was the World Trade Organization during this period? And how did that play out and how does that set the chess board for China to run the tables?
Yeah. So the WTO stepped in when China cut off rare earth exports from Japan, I think it lasted for about 40 days because the US and Japan protested the WTO, and they stepped in and China resumed exports. While I'm not an expert on these trade matters, one thing that I am aware of is that one of the reasons why China had to resume the export of rare earths was it did not legitimately need all the rare earths for domestic consumption. So therefore it was a nefarious act, if you will, to cut off rare earth exports. Now that has changed, which means China have to cut off rare earth exports today, they have a legitimate case to say that they require these materials. There's a shortage of these materials and they require them for their own domestic purposes. It is the backbone of their economy and there's very little we could do about this today, which is why it's becoming an even more urgent issue.
And the US government started stockpiling some of these after that incident. Can you talk a little bit about what DOD and DOE has done to start making sure that there's not a critical supply shortage going forward, and is it enough?
Yeah, again, there is a national defense stock pile, and there are materials still that the United States needs to procure in order to shore up its stockpile. There are magnets, the finished magnet products as well, the United States government needs to stockpile. Again, there's a limited amount that the United States government has. It requires approval from Congress, whether it's in the NDAA or other approvals from Congress, to allocate monies for the national defense stock pile of these materials. That being said, there's no endless supply of these materials. And unfortunately, the apparatus, the way it's set up right now with the US government, it's going to continue to require having a secure supply chain of those materials for many, many years to come. So it's not a question of stockpiling for 10 or 20 years, and then this complacency and saying, we'll kick the can down the road. But keep in mind as well, Ryan, that US government accounts for low single digits of overall rare earth imports into the United States.
We're talking about defense contractors, we're talking about the manufacturing sector. The direct impact this has on the economy, jobs, the automotive sector, and others is significant. So it's not just limited to the United States government. If you look at over the past couple of weeks, the sanctions that China have put on Raytheon, Boeing, Lockheed, et cetera. I mean, the question is where are they going to get those materials? And if we go beyond that, you need rare earths for the 5G network. Now that Huawei has been banned from installing the network, not only in the US but other countries, we have to have the ability to get a secure supply of these materials as well. Which currently, again, trying to control the hundred percent. So it runs across the board, both for government, defense and manufacturing in this country.
Well, and so help me paint a picture for our audience. Does China have all the mines for rare earth, or they're the only ones who started mining it? Or are their mines globally dispersed and nobody's been doing the actual infrastructure to do the mining?
Yeah. So finding rare earth projects or rare earth elements is not the difficult part. It's finding them in significant quantities that makes a project economically viable. And part of that consideration are the environmental rigors that companies in the West have to adhere to. And China, even by their own admission, have had a complete disregard for mining these materials and even for processing these materials. And in fact, just the last week or so, the BBC did an expose on this, 60 Minutes has done an expose on this. But the Chinese have not denied this and have talked about cleaning up their act, but it has an effect on the bottom line for what the costs of mining and processing are if you have no environmental standards to adhere to. So China have exploited those rare earth projects they have, primarily in inner Mongolia, and have brought a number of projects online and quite quickly, and in a significant way, with a complete disregard for the environment.
So it was seen as an environmental no-no in the West for many years. Now, what's happened over the past few years is you're starting to see rare earth projects in different parts of the world sprout up. You've got the Mountain World project in Australia owned by Linus, which is a producer of Nd and Pr, neodymium and praseodymium. So two of the light rare earths. They may have some heavy rare earths coming online at some point in time. And you've got Arafura, which is another company in Australia that we're working with to assist them with their processing so they don't have to send the materials to China for processing. But really these are a drop in the bucket for what the requirements are for the United States. And certainly what the requirements are for allied countries, the EU, et cetera. So there is a race, if you will, worldwide to start bringing projects online. The Chinese are very active in trying to secure assets outside of China.
So in Africa. They have ownership of a project in Greenland. So there is somewhat of a race. The Australian government has stepped in and has started limiting the ability for China to own, or have ownership in, or off takes for the Australian rare earth projects. And that's part of the strategic Alliance between Australia and the US. Canada, similar thing as well. There are a number of projects that are looking to come alive, but these projects are, for the most part, will take many, many years to come online. We have to expedite the process. We have to assist with a [inaudible 00:14:41] supply chain and the domestic rare earth sector, because previously investors have been scared off by things like China flooding the market, which is not a possibility at this point in time, given that China can't actually afford to flood the market. They are already very heavily subsidizing their mine to magnet supply chain there.
This is more now a case of being able to get production from non-Chinese sources so that the United States and allies have a viable, secure supply chain of these materials. And it's a concern worldwide. We speak to governments all over the world, and we're all facing the same issue. Some more than others, especially countries like Japan, that don't have their own rare earth projects there and are reliant on Australia where they've made some investments there. And in the United States, they've made an investment recently in Africa. So there is this race, if you will. And I think we've got a five-year window here to at least stand up a few projects worldwide. Otherwise we've lost this race and we will be dependent on China for many, many years to come. And Ryan, it's a bit of a hypocrisy. If you look at it where you've got materials going through clean, green energy applications, like electric vehicles, wind turbines, et cetera.
That we're sourcing these materials from China, where they've, again by their own admission, has been complete environmental devastation to water bodies around these mines and processing facilities, to the communities. People have been getting sick around these projects yet we're putting these materials into our electric vehicles or wind turbines. It makes no sense at all. And people are starting to wake up to this. And that's why the sector is starting to see a lot of support come out of Congress and bi-partisan support. And in fact, it's one of the only bi-partisan issues right now in Washington. And it's good to see that some things decided to move in the right direction.
And is there a special process? You talk about the expense, is it really difficult to mine these? You have to go through a special chemical process to extract and clean and purify. Is it a lot harder than, say, gold or silver or some of the other, we'll call, more traditional elements?
Yeah. It's all about the processing to some extent. So if you look at MP Materials in California, which used to be Molycorp before they went through their bankruptcy. They are a miner of Cerium and Lanthanum, which are two of the light rare earths, the lower valued light rare earths. Given that they do not currently have processing technology, they are sending those materials to China for processing where China is tariffing those heavily. Linus is also, they're doing their processing work in Malaysia and elsewhere. So it's really about the processing at this stage. One of the things that we've done, after we put out our PDA last year with our upgraded resource, which now includes a significant amount of lithium. We make a decision that, based on the test work that we had done around our processing methodology, that we were not going to send our materials to China. That it's paramount for us to do this work in the United States and in a collaborative effort as well.
We've been asked by some of our investors, "Well, why would you be looking to help other projects with their processing?" And the answer is simple. There's no one project or one company that's going to put China out of business or make a dent, or somehow be able to take care of the overall demand worldwide for rare earths and critical minerals. And it's very important for us to have processing capability in the West. So that was the impetus for us opening up our own rare earth and critical minerals processing facility earlier this year, which we did in Wheatridge, Colorado. And in fact, we've made some significant progress on the method that we're using for this. And we're starting to collaborate with Australian companies, Canadian companies. We're currently talking to a group over in Europe as well, because this has to be a collaborative effort.
How does Europe solve for these problems? Do they have this better under control than the US?
No, they're in a far worse position than we are. The EU commission recently put out a report, I think, a couple of months ago that the requirement for rare earths is going to increase tenfold within a short period of time. Lithium 18 times. They don't really have rare earth projects. Again, there are the Greenland projects, which people have heard in the news recently. Those need to further development work so they don't have rare earth projects ready to come online there. There are a couple of lithium projects that are spread around Europe, but for the most part, Europe is in an even more precarious position. If you look at Germany with the auto manufacturers, you look at the big companies like ThyssenKrupp and others, all these countries and companies are looking for alternatives to China, because we've already seen in the news about China withholding or reducing exports of some of these rare earths that are required for these industries.
And you mentioned earlier the regulatory posture of the US makes it difficult to mine. Is it becoming a more bi-partisan issue that we need to maybe relax some regulation around the mining exercise, to incentivize private sector to come in and start producing this? Or is the Republican party versus the Democratic party on two separate pages of music?
Yeah. Good question, Ryan. I mean traditionally the Republican party is obviously being more pro-mining and in favor of less regulation when it comes to these things. With regards to our project, we're on Texas state land. So we don't trigger federal environmental permitting at this point in time. And obviously Texas being Texas, a mining state and oil and gas state, things are a lot easier in Texas than they are on projects on federal land where the Bureau of Land Management controls the environmental process around that. But the thing is here, and I don't want to step into what other companies are doing, et cetera, but we do need to be reasonable about allowing projects to come online if they're adhering to environmental standards that are acceptable worldwide. And what we do know, is that China is destroying the environment and cities and water bodies around their mines and processing facilities.
We have standards here in the United States, and I think what we need to do is make it easier for companies to mine, while at the same time protecting the environment. And there are ways to do that. And we're definitely seeing buy-in from Congress, from both sides, with regards to looking how we can stand up a secure supply chain. And, obviously under the Obama administration, they had very strict regulations when it comes to mining. And that's changed under the Trump administration. Hopefully what we start to see is some normal middle ground that'll allow other projects to come online.
And typically in these rare earth mines, is it amalgamation of different minerals that are all consolidated together and you have to separate them out? Or do you ever find pure play, Europium, I can't even pronounce some of these. Gadolinium, Cerium. I mean, are they all mixed together and you've got to filter and sift them through, or are they pure play mines?
No, they're generally they have a mix. So they're polymetallic projects. They have a number of different materials. Some projects, you more to what we call the light rare earths like MP in California or Linus in Australia. Our project is actually on the opposite end of the spectrum. We have a very high concentration of heavy rare earths. That being said, we do have to go through a process of separating these materials. But the case of our project where we've got 30 materials. We're not going to produce 30 materials. We're not going to market 30 materials. So what we're doing is we're focusing on the key materials that are marketable, that we need for permanent magnets, lithium as well, and working on the separation and the optimization of those materials in particular. But we're all faced with the same processing challenges and that is something that can't be set.
There's no easy way to do this. There are different technologies that have been used in different parts of the world. So predominantly there's a process called solvent extraction, but it's big, it's bulky, it's not benign. It's a bespoke solution for one particular project. So it doesn't work for feedstock from other projects. What we've done is we're using a processing technology that's actually been around since the 1940s. It was part of the Manhattan Project. It's called continuous ion exchange. In fact, the Chinese use it to increase the purities from 99.99 to four nines, five nines, and even six nines. So for some applications you require higher purity levels. It's a far easier processing method to scale up and to take feedstock from other projects. In fact, we've demonstrated for the Department of Energy that we can take coal waste from Pennsylvania and do high purity separation of rare earths using our processing methods. So it's not a step that can be skipped unless one needs to send it to China for processing, which is not going to help us with our objectives here.
How many other, we'll call it, going concerns on any other businesses that are doing this, that are trying to, I guess, start the development of these mines. Are you guys one of a few or are you one of many? And is it an international or just a US game? Who's leading the charge at going after this?
Yeah, well, I'd say the Australians are leading it outside of China right now. You've got some really good projects in Australia. Again, more skewed toward the light rare earths. There's one more heavy rare earth project in Australia, which is not yet producing. The United States, you've got MP Materials, you've got Ucore in Alaska, you've got the Bear Lodge project in Wyoming, which is also another light rare earth project. So as far as a heavy rare earth project that looks like it will come online in the near term, that would be our project. In Canada there are a couple of projects there as well, and again, more skewed toward the light rare earths. But we really need to get as many of these projects online as possible. Because again, I don't see it as competition. We all have a problem doing supply agreements or offtake agreements for our materials.
In fact, one of the things that we're going to have to consider is looking at potentially scaling up our production, based on the demand that we're already starting to see. And I think other companies would find that as well. So it's all about the economics of the project. You have projects that were economically viable back in 2012 or rare earth prices with 35% or so higher than they are today, and are not necessarily viable today. So that's the challenge as well, economically viable projects. And we've got to get as many of them online as possible. It takes many, many years. I mean, our project has had over $70 million put into it to get to where we are today, and we're close to getting to the production scenario. It all revolves around processing at this point in time.
We'd be very happy to see another couple of projects come online, because this is extremely important for national security and for the economy as well. I mean, if you think about it, Ryan, if you've got a billion dollars of rare earth materials, that translates into a trillion dollars or I should say trillions of dollars of finished product. So you've got a magnet in your phone there that's worth a couple of dollars and the cell phone's a thousand dollars. And electric vehicles and defense applications even more.
Yeah, everyone has one of these iPhones now, and there's tremendous amounts of rare earth on the circuit boards here. And I think people take it for granted that that supply chain is not secure right now. So one question for you, there's talk of this maybe medium term to longterm, but there's talk about mining in space. Do you think that's a feasible option in the longterm, medium term? What are your thoughts on that?
No, that's just ridiculous. I mean, we're trying to find ways to make mining on earth economically viable. I think the cost of going up to space would be more than what our capex will be bringing our entire project into production. I mean, we've got about a 350 to $400 million capex to bring 130 year mine life into production. I'm not an aerospace expert, but I think sending a rocket, building a rocket ship and sending it up, I think maybe on the fuel alone, you could bring a couple of projects into production. So unless we have a fortunate situation or an asteroid lands on earth, and fortunate if it lands somewhere where we don't care, I don't see how that happens. And if it's big enough, it's a problem as well. It's nonsense. And even, options aside of the deep sea mining for rare earths, I mean, you've got all sorts of environmental issues around that as well. I think we need to look at projects that we can bring online, that can be done so in an economic way, that can be done so in an environmentally responsible way.
I mean, one of the things that we've done at our project is we've got in excess of 60% of the materials that have come out around top, will have a clean green energy applicability to them. So we're using the benign processing method. We're going to be using renewable energy on site. In fact, we will likely be putting a solar farm on site as well. We've talked to a couple of companies that have approached us about that, and we'll be a net producer of power for the surrounding area. So there are ways to do it which don't affect the environment. Obviously if there's a project that's situated on a sensitive area, that's a unique situation for that specific project. We've seen it with the Pebble project, which is not a rare earth project. The Pebble project in Alaska where their environmental concerns is we've been recognized by both Republicans and Democrats, but we have to be reasonable about the projects that don't have environmental concerns.
So Pini, in season two, we ask all of our guests a series of six questions. They're usually, yes, no questions, but trying to take a survey of our conversations. And if you want to add a little context to the yes or no, feel free, but here goes the first question. If there was a COVID vaccine available today, would you take it?
Who do you think is going to win the election?
The US election.
Well, I think it looks like Joe Biden's going to win it, but I think what happens, if we go past January six from my understanding is that the house will vote on it and it's one vote per state. But I don't know if I see it getting there at this point in time. I really don't have a crystal ball.
Third question. What type of economic recovery are we in? What type of shape is it taking? A V-shape, W, U, L?
Yeah, I think 2021 is going to be challenging. I think we've been, and rightly so. I mean, we've had no choice as of almost every other country. We've been printing money for the past year because of COVID. And I think we've got to brace ourselves that, at some point in time, the chickens come home to roost. It was a necessary step. People needed it on an individual level. Businesses needed it as well, but I think we've got to do whatever we can to stimulate the economy, give people confidence to go out and work again, employ people. So I think we've got to watch ourselves, especially in 2021. And I have some concerns, but long-term, I think the approach in the United States is a healthy one.
During lockdown this summer and quarantine, was there anything in particular that you accomplished that you're particularly proud of?
Yeah. A great amount of family time, which, if you would've asked me a few years ago if I could sit at home and be at home for six months, I would have told you absolutely not. I wouldn't be able to do it for six days, but it has... I'm sure it's done this with a lot of families as well. It's brought families together. We had a baby actually last year on Thanksgiving. So I was doing a lot of travel at the time and thought I wouldn't get to see my daughter in her first year or couple of years too often. And being home with her every day is actually been just the most amazing experience. So thankful at least for some silver lining in COVID.
Are there any silver linings that you see in the economy going into 2021?
Yeah, I think we've gone through an absolute beating and it looks like we've got the ability to come out of it. And I think that's a testament to how strong the economy was built up in the years preceding COVID. So overall I remain an optimist. I mean, we are a country built on opportunity and going out and making it happen. And we're not a socialist country sitting and waiting for people to send us paychecks or wealth distribution or anything like that. I think the American dream still lives on. I think if you go out and you're willing to work and put your head to it and heart in it, I think we do have the ability to climb out of it. So if we look at what the economy is doing over the past few weeks, it looks like it's starting to rebound. And to me, that's assuring because it could go completely one way as well.
And the last question is, is there anything that you're watching, or listening to, or reading today that has been impactful on your thinking that you'd like to share with our audience?
Yeah, that's a good question. I think it's been more personal stories. The news, I sort of take that in context or with more than a grain of salt. In some cases stay off the news channels for a number of days at a time, it became quite repetitive. But I think on the personal side, talking to friends, my family's all back home in Australia, they've just come out of 110 day lockdown, which we can't relate to that. It's been very trying on them and seeing the fortitude that they've had to come out of that and stay intact. I think the mental health issues that will come out of COVID are going to have a far longer effect than the economic issues. I think we're going to have to focus on mental health issues in this country for a long time to come.
The impact on kids has been significant with regards to lockdown or remote schooling, et cetera. But to see people come through it. I think it's a testament to people in general and to the country and other countries as well, to see got that fortitude and survival instinct to try to get through whatever adversity we can. So hearing the personal stories, the challenges that people have gone through, I think it's made me a lot more aware of things that I have to be thankful for and where we can help out other people as well. I think we have to be united going forward because there are things...
I think one of the things that COVID has shown us is we can get into this complacency and life goes on and we go one day to the next. And all of a sudden we get hit by something that affects everybody equally. I mean, COVID, whilst there were groups of people, whether it was the elderly or people with underlying health conditions, that got hit the worst. I mean, we all got hit in some form or another. So really, this should be something that unites us, not divides us.
Well, Pini, I appreciate you coming on today to talk to us a little bit about the supply chain crimp on rare earth and we'll definitely keep an eye on it and would love to have you back in the future.
Thank you, Ryan. Thanks for having me.
Absolutely. Thank you. Bye-bye. Thanks for watching Non-Beta Alpha. And before we go, please remember to like, and subscribe on Apple podcasts and our YouTube channel. This is Non-Beta Alpha, and now you know.
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