- Zepf's PhD. thesis sheds light on the fact that we have very little knowledge of REE supply/demand fundamentals.
- His empirical approach to rectify this information gap only serves to illustrate just how little we know.
- This brings the bullish thesis under scrutiny, although there are other factors that Zepf simply cannot cover given the information available to him.
- There is a place for REEs in your portfolio, but you need to be extremely cautious.
Recently I had the opportunity to read Volker Zepf's PhD. thesis: Rare Earth Elements--A New Approach to the Nexus of Supply, Demand and Use: Exemplified along the Use of Neodymium in Permanent Magnets. It was recommended to me by a contact at a rare earth element (REE, hereon) junior mining company. Ironically, the thesis of the work questions the popular bullish narrative that drove prices higher back in 2010-11 and which keeps the bullish spirit alive during the recent bear market. While the author certainly has no intent to argue a bearish case, his goal is to point out how little we really know regarding the supply/demand dynamics of the REE market.
The work has 8 chapters the author achieves three things for the reader. First, he gives an overview of the REE market. This part of the book is actually very similar to the standard narrative that we have been fed regarding the REE market. REEs are comprised of the 17 lanthanoids and they have certain attributes in common, while at the same time they also have very different qualities and occur in varying frequencies in the Earth's crust. Most of them are produced in China although there are several other undeveloped REE rich deposits in other parts of the world such as North America, Africa, and Australia.
In short the first part is simply an introduction for readers who aren't really familiar with the REE space, although it is a good read considering that Zepf doesn't approach the topic as an investor, and most of the material that I have read, and that you have read (considering this is an investment forum) probably comes from that perspective. So even if you think you know this stuff the early chapters are worth your time.
Then Zepf goes on to do something very interesting. He looks at several of the main sources of REE supply and demand data and comes to the conclusion that it basically comes from one source. Most sources cites the United States Geological Survey (aka the USGS) either directly or indirectly, which in turn gets its data from Dudley Kingsnorth, who gets his data from the China Rare Earth Information Center (the grey image on the following graphic)... He illustrates using the following graphic.
Zepf finds this to be extremely problematic and he concludes that there is hardly anything scientific about the REE production data that is often cited by investors or researchers. After all if the information were scientific it would come from several independent sources of concrete, empirically verified data as opposed to a Chinese propaganda mill.
Perhaps this is a glib way of putting it but the conclusion is the same no matter how we put it: the true supply/demand fundamentals of REE is a mystery.
How, then, are we to approach this problem scientifically? There is no easy answer and Zepf is the first to admit that he doesn't have a practical solution given his own time and financial constraints. However he does provide a starting point, and this is the third part of the work.
Zepf focuses on one of the REEs--neodymium--which is used in permanent magnets comprised also of iron and boron. REE "mythology" (which we now see is an appropriate adjective) would have us believe that cell phones, hard drives, wind turbines, and electric cars comprise about 80% of the demand for neodymium.
Zepf puts this to the test by literally opening up cell phones and disk drives and weighing the neodymium content. He then uses projections for total neodymium demand in these products by using recent sales data for these goods. For products that he cannot practically analyze himself given the resources available to him (e.g. electric cars and wind turbines) he reluctantly relies on the data provided by the companies that produce these items.
The results are somewhat surprising. Even though Zepf would be the first to admit that the data he presents is incomplete the aforementioned sources of neodymium demand don't even come close to comprising most of the world's neodymium demand. Even if he projects past growth rates into the future the same can be said in 2020, as the following table illustrates.
Thus not only is the generally accepted data regarding REE supply and demand questionable, but there is reason to believe that the commonly accepted and preached narrative regarding REE demand sources is dead wrong.
What Does This Mean for the Investment Thesis?
The fact is we simply have very little information regarding the demand sources for REEs. Zepf picked neodymium thinking that this was the least opaque of the 17 REEs, and it turns out that his data was inconclusive--where is the other 80% of demand coming from?
The clearest answer to this is national defense. Of course this is also going to be an area of demand that global governments--the Chinese and American governments in particular--are not going to shed any light on. We know, for instance, that the Chinese are stockpiling REEs. We have seen intermittent announcements to this effect, with the most recent coming just a couple of weeks ago. Bloomberg's report that China stockpiled 10,000 tonnes of REEs (nearly 5% of annual production) is peppered with the notion that the Chinese want to increase prices, but there is simply no rationale for this. The simple fact is that the Chinese need REEs. Similarly in the U. S. the DoD and the USGS have shown particular interest in Ucore's (OTCQX:UURAF) Bokan Project in Alaska.
Still, it is impossible to make a definitive investment case without concrete numbers, and ironically if the demand estimates coming from the Chinese and U.S. governments are bullish then it would be in their best interest not to reveal this fact in order to keep prices down.
Another point to make is that neodymium is just one REE. In a discussion with Anthony Marchese of Texas Rare Earth Resources (OTCQX:TRER) he told me that an increase in supply of some of the particularly rare REEs--erbium, terbium, ytterbium, holmium, lutetium...etc.--would lead to additional research by businesses looking to use these metals' unique properties. So one's bullishness on, say, holmium, is predicated on the metal's unique magnetic properties that one day will be exploited should there be a reliable holmium source.
The bottom line for investors is that there is an unparalleled opportunity in the REE space, but this opportunity you need to bet small because it is so unpredictable. If there is so little information regarding neodymium demand--with neodymium being the most "mainstream" REE --then the rest of the space, and the extremely rare heavy REEs in particular, must be approached with extreme caution. At the same time there is reason to assume that these metals will be essential to the future of modern industry, and the company's that wind up producing them in bulk could become the BHPs of the future.
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