Special Report: Rare Earth Primer: Chinese Manipulation and Future Opportunities

China sometimes reminds me of a schoolyard bully that no one has the stones to confront.

He'll take your lunch money, make you do his homework, and run your pants up a flag pole during a particularly cold and rainy day...

Or in this case, hoard the world's supply of rare earth metals.

The global investment and manufacturing community's disdain for Chinese manipulation of rare earth markets has led the World Trade Organization (WTO) to rule against China's stockpiling. If China doesn't abide by the ruling, it can be sanctioned.

Of course, by the time they get around to doing that (which could take years), all those WTO hearings and sanction threats won't even matter anymore...

Because by then, true seekers of wealth will have already turned the tables on China's rare earth bullying — and made billions as a result.

Sidestepping China

As you may know, rare earths are found in everything from magnets and smartphones to radar equipment and hybrid vehicles. But don't think for a second that manufacturers of all these products are waiting around for some kind of WTO ruling to save their businesses from ruin...

The fact is any company that relies on rare earths today is either actively developing new technologies that rely less and less on rare earths — or they're simply getting in on a wave of new non-Chinese rare earth producers.

Take Toyota (NYSE: TM), for instance: The automaker has invested in non-Chinese rare earth producers as a hedge, including a Vietnamese mining company that signed off on one such deal just a few months ago. And Toyota recently announced it has developed a way to make hybrid and electric vehicles without rare earths...

The new technology could start appearing in the market within two years.

A Rare Earth Bonanza

As much as 95% of the world's rare earth elements are produced in China. And it is becoming increasingly urgent for developers to find REEs in other parts of the world.

This becomes more and more apparent every time I talk to high-performance battery manufacturers and companies that rely on rare earth magnets for things like wind turbines and energy efficient electric motors.

Bottom line: China needs those REE supplies for its own consumption.

And in the not-too-distant future, those supplies found outside the Middle Kingdom will be the only supplies we'll be able to get our hands on.

So here are a few companies that are operating in this sector that are not based in China:

  • Avalon Rare Metals, Inc. (TSX: AVL) – projects in Canada
  • Great Western Minerals Group (TSX-V: GWG) – projects in Canada, South Africa, and the United States
  • Hudson Resources, Inc. (TSX-V: HUD) – projects in Greenland
  • Rare Earth Metals (TSX- V:RA) – projects in Canada
  • Commerce Resources Corp. (TSX- V:CCE) – projects in Canada

And of course, there's Molycorp (NYSE: MCP), which is the only major U.S. public producer of rare earths. This company is ramping up operations in Mountain Pass, California, just about 15 miles from the Nevada border. Molycorp recently started extracting ore and expects to average 40,000 metric tons per year of rare earth oxide ore from the Mountain Pass mine.

During 2010, all six of those stocks delivered massive gains...

Take a look at their returns:

  • Avalon Rare Metals: +158%
  • Great Western Minerals: +221%
  • Hudson Resources: +118%
  • Rare Earth Metals: +78%
  • Commerce Resources: +135%
  • Molycorp: +293%

It was a record year not only for rare earth stocks, but also for rare earth prices...

Lanthanum, for example, went from $5/kilogram to $140/kilogram — a 2,700% increase — and many other rare earths followed suit.

The increased prices put the pressure on companies to reduce their rare earth consumption or find substitutes. And in that wake, prices have receded...

Heavier rare earth elements are scarcer, and are expected to see rising demand in applications such as high-performance magnets and energy-efficient lighting. As a result, they are worth a lot more and did not lose as much value.

For example, Lanthanum oxide is only worth about $13.00/kilogram, while terbium oxide is worth about $1750/kilogram.

As the New York Times reported:

After nearly three years of soaring prices for rare earth metals, with the cost of some rising nearly thirtyfold, the market is rapidly coming back down.

 

International prices for some light rare earths, like cerium and lanthanum, used in the polishing of flat-screen televisions and the refining of oil, respectively, have fallen as much as two-thirds since August 2011 and are still dropping. Prices have declined by roughly one-third since then for highly magnetic rare earths, like neodymium, needed for products like smartphones, computers and large wind turbines.

 

Big companies in the United States, Europe and Japan that use rare earths in their manufacturing have been moving operations to China, drawing down inventories, switching to alternative materials or even curtailing production to avoid paying the extremely high prices that prevailed outside China over the summer.

The Next Chapter

You have to remember that we're dealing with China here...

With demand and prices currently falling, many Chinese rare earth companies won't meet their export quotas this year. When that happens, the Chinese Commerce Ministry typically penalizes exporters by giving them smaller quotas the following year.

Not only that, but China's largest producer, Inner Mongolia Baotou Steel Rare-Earth, halted production for a full month in 2011 and late 2012 in an attempt to stoke prices. Other companies followed suit...

Even worse (though better for investors), the Chinese Commerce Ministry also blocks companies from exporting rare earths at prices it deems too low, which inherently means we have a price floor. (Cerium, for example, is currently fetching $25 per kilogram, but China won't export any for less than $70.)

These latest moves by the Chinese have prompted Congress to start researching the creation of a U.S. strategic rare earth reserve, which would serve (at least initially) to foster demand growth.

According to a Financial Times post, several rare earth CEOs have said the creation of a rare earth reserve could potentially create “a rebirth of the U.S. rare earths industry.”

I agree.

With less than a handful of rare earth mines in operation outside of China, continued price fixing games, and the growing use of handheld electronics... any company with access to supply is going to fetch a premium market price.


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