Graphite has not been on the radar of most investors until now. This is more than a flashback to the #2 pencils you had to use to fill in those annoying answer sheets in school. Graphite is an excellent conductor of heat and electricity and has the highest natural strength and stiffness of any material known to man. It is a key ingredient in aviation, automotive, steel and plastic industries. High-purity large-flake graphite is also essential for the production of the lithium-ion batteries, where demand is growing rapidly due to the evolution of electric cars. In fact, there is 10 times more graphite than lithium inside a lithium-ion battery.

The supply/demand fundamentals that make graphite attractive as an investment are similar to those of rare earth metals. The British Geological Survey listed graphite, along with rare earth metals, as those at most risk of global supply disruption. Industry experts report that China’s 2010 graphite global market share was around 75%. In an effort to retain its graphite resources, China has restricted its graphite supply and has imposed a 20% export duty plus a 17% VAT. As a result, graphite prices have started to rise, particularly for graphite flake styles which are now commanding between $2,000 and $3,000 a ton depending on flake size.

But the really exciting driver of investment demand in graphite is the future potential of ‘graphene’, which is composed of tightly bound carbon atoms. So what is all of the fuss about?

To start off, it is the thinnest and strongest material ever developed. It is 200 times stronger than steel and several times tougher than a diamond! Furthermore, it conducts both electricity and heat better than copper. Many believe it will soon replace silicon in semi-conductors and researchers claim it is the most important substance to be created since plastic.

Graphene was first isolated by Professors Konstantin Novoselov and Andrew Geim at Manchester University in 2004. The pair used sticky tape to strip away thin flakes of graphite, then attached it to a silicon plate which allowed the researchers to identify the tiny layers through a microscope. They were awarded the Nobel Prize in Physics for 2010 “for groundbreaking experiments regarding the two-dimensional material graphene.”

Interested yet?

If it lives up to its promise, it could lead to mobile phones that you roll up and put behind your ear, high definition televisions as thin as wallpaper, and bendy electronic newspapers that readers could fold away into a tiny square. Check out the video to get an idea of what future applications may look like.

Graphene has the potential to make solar panels several times more efficient, semiconductors several times faster and aircraft a fraction of their current weight. It will also play a key role in emerging consumer electronic technology and has the potential for countless stealth military applications.

There are some drawbacks to consider. Earlier this year IBM admitted that it was ‘difficult to imagine’ graphene replacing silicon in computer chips and skeptics point out that it is difficult to make into large sheets. And there are already some problems with using graphene. It is so good at conducting electricity that turning it into devices like transistors — which control the flow of electrical currents, so need to be able to stop electricity flowing through them — has so far proved problematic. Some say it will take at least 5 years before commercial use and prices could drop as there are reports of over-capacity at the current moment.

While graphite is not as scarce as rare earth metals, it is relatively concentrated with China producing 70 to 80% of worldwide production. Prices have risen sharply in the past few years and as new usages are discovered, I believe they will continue to climb higher. I also believe that Graphite producers could see increased interest in the short-term, as more and more investors become aware of the potentials of graphene. Just last week, the Gold Report published an article titled “Graphene – The Miracle Metal That Will Change the World.”

If investors rush into the few graphite miners outside of China the same way they did with rare earth companies earlier this year, we could see stock prices spike dramatically higher.

Rare-earths expert Jack Lifton likes China Carbon Graphite Group (CHGI.OB) and GrafTech International (GTI). However, these companies are down 70% and 30%, respectively, since the start of the year.

There are two other companies that I believe have significantly greater potential and both have outperformed the companies mentioned above in 2011…

#1 Undervalued Graphite Play
The first company is fast-tracking towards becoming one of the lowest-cost producers in the world and recently reported a 43-101 compliant resource estimate. They plan to perform a feasibility study next year and begin construction shortly after, with the potential to start production in 2013. Their share price has advanced nearly 50% this year, although it would still need to more than double to reach the 2011 high.

#2 Undervalued Graphite Play
The second company has completed a NI 43-101 Preliminary Economic Assessment Report, has initiated a bankable final feasibility study and has commenced the environmental and mine permitting process. They are planning to commence mine construction early in 2012 and begin producing in 2013. The company is well funded and trading near all-time lows.

I believe that both of the above stocks are undervalued at current graphite prices and severely undervalued if the upward price trajectory continues. If you would like further details on the graphite plays that I believe are ready to explode higher in 2012, please sign up for the Gold Stock Bull Premium Membership. You can try it out monthly or save by purchasing an annual subscription at the new discounted rate.

I never accept compensation to promote any stocks and have not been compensated in any way to write about graphite or any particular graphite companies. I do not currently hold positions in any graphite stocks, but plan to purchase shares in one or both of the companies teased above in the coming weeks and have brought these companies to the attention of Gold Stock Bull premium subscribers.