Seeking Alpha
Dr. Duru, One-Twenty Two (112 clicks)
Long/short equity, event-driven, homebuilders, currencies
Profile| Send Message| ()  

Last week, an article from China Daily titled “Rare-earth supplies expected to grow” was blamed for the weakness in several rare earth stocks like Molycorp (MCP) and Lynas Corp. Ltd (OTCPK:LYSCF) on June 16. The article contains numerous quotes from Chen Zhanheng, director of academic department, the Chinese Society of Rare Earths (CSRE).

It is important to remember that China Daily is essentially a megaphone for the Chinese government. According to the New York Times (Oct 18, 2010): “China Daily is owned and closely supervised by the Chinese government, and presents official views on a wide range of issues.” Given the U.S. and Europe have threatened to challenge China’s export quotas on rare earths in the World Trade Organization (WTO), China has every reason to promote news and studies that reduce that pressure. A forecast of imminent abundant supply appears to defend China’s position.

Zhanheng states the following in an important quote from the article:

Overseas demand for rare earths has stood at an average of 50,000 tons annually in the past few years…’Global supply of the minerals, particularly the light-type, which exists in abundant deposits overseas, will soon surpass demand, despite China’s curbs on the metals.’

Of course, “the past few years” includes a worldwide, economic collapse that interrupted a steady increase in demand for rare earths. Moreover, aggregating demand numbers is not too useful. For example, the tonnage of demand for cerium and lanthanum (light rare earth elements or REEs) dwarf the size of demand for other rare earths. Two other light REEs, neodymium and europium, have enough demand and high enough prices to drive projects with high-grade ores (for example, see Molycorp and Lynas).

Zhanheng also claims that the high prices of rare earths will encourage more producers who will then bring ample supply to market. He uses production targets in other countries to conclude “…a total of 60,000 tons of rare earths will be produced outside China by 2013 and 170,000 tons by 2015.”

I feel we have already seen some version of this episode. Goldman Sachs (GS) set off a firestorm of controversy in early May when an analyst claimed that rare earth prices would peak in 2012 as the industry moves from deficit to over-supply after 2013. Jack Lifton, a leading authority on the sourcing and end use trends of rare & strategic metals, was particularly adept in debunking the thesis in “In Xanadu Did Goldman Sachs Decree A Rare Earths Surplus For All To See” by demonstrating the flaws in treating rare earths as one large substance and by pointing out the limited production outside China. Lifton also questioned the quality (or even relevance) of production planned by many junior miners going out to 2015. Zhanheng’s supply forecasts must assume that non-commercial projects will somehow get funded.

Zhanheng’s comments imply that overseas demand for rare earths will remain at 50,000 tons for the foreseeable future, but he does not volunteer estimates for China’s demand. This is relevant because, for example, Lynas has claimed China will soon become a net importer. Dudley Kingsnorth claims that China’s demand will equal its production by 2014, and Molycorp starts with this estimate and rolls back the moment of truth to 2012, when taking into account wind turbines and a continued economic recovery (see p27 of “China’s Rare Earth Elements Industry: What Can the West Learn?” by Cindy Hurst, March 2010, Institute for the Analysis of Global Security (IAGS). Hurst works for the U.S. Army’s Foreign Military Studies Office). On June 6, 2011, reports appeared that the U.S. Geological Survey submitted estimates to Congress that demand for rare earths will increase 8% per year (still waiting for official publication of this report). So, even if overseas demand remains static (with China increasing control over the manufacturing of products using rare earths?), it seems highly likely that Chinese demand will be enough to keep general rare earth supplies short.

Notably, the Chinese Rare Earths Industry Association has provided a much different forecast than Zhanheng. From the New York Times on October 18, 2010:

“Wang Caifeng, the secretary general of the Chinese Rare Earths Industry Association, predicted at the conference in Xiamen on Tuesday that domestic demand for rare earths in China would soar to 130,000 tons in 2015 from 75,000 tons now, Bloomberg reported. She said that world consumption would be 210,000 tons in 2015, which would seem to indicate that consumption outside China would total 80,000 tons.”

China’s efforts at creating domestic reserves belies predictions of imminent over-supply. For example, on June 15, 2011, the WSJ reported in “China To Set Up Strategic Reserve For Heavy Rare Earths -Sources” that China may be moving forward with a heavy rare earth strategic reserve in addition to plans already in place to build a strategic reserve for light rare earths. Reserves create incremental demand for a resource. Accordingly, Lifton makes the ominous prediction that:

“Unless the rest of the world now shifts its focus to the production of heavy rare earths and their stockpiling, then by 2015 at the latest, there will be virtually no HREEs available outside of Chinese control, and thus, any manufactured product requiring a HREE will by necessity have to be made within China by a manufacturer who is either Chinese or has access to quota ultimately issued by the Chinese authorities.”

The upshot is that all this stockpiling will help drive REE prices ever higher for at least the duration of these stockpiling programs and likely longer.

Finally, on June 17, 2011, we received a reminder of China’s tightening grip on supplies that continues to drive REE prices skyward. In “Rare Earth Prices Double on China, Industrial Minerals Says“, Bloomberg reports:

“Prices of some rare earths, used in hybrid cars and laptops, have more than doubled in the past two weeks as China seeks to tighten control of mining, production and exports, Industrial Minerals said. Dysprosium oxide, used in magnets, lasers and nuclear reactors, has risen to about $1,470 a kilogram from about $700- $740 at the start of the month, Industrial Minerals said in an e-mailed statement.”

On balance, I find plenty of reason to believe that the supply of rare earths will remain challenged for quite some time.

Source: Chinese Academic's Rare Earth Forecasts at Odds With Industry Experts