As China continues to leverage the pricing power built into its rare earth quota system, and the U.S. continues to review its strategic policies in response, REMX investors may wish to consider adding to positions.
According to the U.S. Department of Energy’s December 2010 report entitled Critical Materials Strategy:
Recognizing the evolution of the market for rare earth elements (REEs), in the summer of 2009 the Office of Industrial Policy/AT&L, Department of Defense (DoD) self-initiated a review of the U.S. supply chain.
The rationale for this effort included the U.S. dependence on a sole supplier that is not domestic, the importance of REE in certain defense applications and forecasts for a surge in demand for commercial end uses that could strain global supplies. Recent events in the global market for REE have reinforced the department's concern regarding reliable and secure supplies of REE.
Some clichés are well worth remembering and often serve investors well should they choose to pay attention. “History often repeats itself” comes to mind. When the government involves itself in the supply of materials of any kind, one may be rest assured that market manipulation and the enrichment of speculators will become part and parcel of the equation.
The Reconstruction Finance Corporation (set up after the Great Depression to basically do what Ben Bernanke and the Federal Reserve Bank are doing now to salvage the U.S. economy, was used by Roosevelt to manipulate the price of gold vs.the dollar in order to lower the price of exports, and thereby "theoretically" creating more jobs) eventually became the policy instrument of the U.S. government whereby to authorize the stockpiling of war materials in World War II. Out of the RFC was born the Metals Reserve Company, Rubber Reserve Company, Defense Plant Corporation, Defense Supplies Corporation, War Damage Corporation, U.S. Commercial Company, Rubber Development Corporation and Petroleum Reserve Corporation.
These corporations helped drive the market for rubber and other commodities during World War II. During this time, price controls were implemented by Roosevelt, but the suppliers continued to profit. In the U.S. Dept. of Commerce's August 1941 Survey of Current Business, it was noted that:
“Other materials important to the defense effort imported in large volume in May were copper ($9.9 million); tin ($13.7 million); and wool ($18.7 million). As the stockpiling program is now conceived, only a portion of the total materials the United States hopes to acquire have been delivered thus far.”
Thus, the Metals Reserve Company was soon stockpiling copper and setting prices. The same report notes:
“Confronted with a shortage, the Office of Production Management on May 31 issued a General Preference order placing copper under mandatory control, and refiners were ordered to set aside each month for allocation by the Director of Priorities an amount equal to 20% of April production. Metals Reserve Company copper was also to be so allocated. On July 9 this order was amended to require both fabricators and refiners to accept orders bearing preference ratings and to use available copper first for such orders. Since early August the entire supply has been allocated by the Division of Priorities and the Office of Civilian Supply.”
A ceiling of 12 cents per pound was placed on copper. However, subsidies were used to increase the stockpiles as more copper was needed:
“In the copper industry, as a case in point, companies were given quotas and rewarded with a premium of 17 cents per pound for all output in excess of their quotas. In free markets, price tends to reflect the marginal cost of production, which means that all units of output tend to sell for the relatively high cost of the marginal outputs. In 1943, about 21% of the copper supply was subsidized in this fashion, costing he government almost $25 million.” (Source)
In 1975, with the Energy Policy and Conservation Act, President Jimmy Carter set up the Strategic Petroleum Reserve (offshoot of the Petroleum Reserve Corporation) and by July of 1977, oil was being pumped into coastal salt reservoirs in Louisiana and Texas on the Gulf of Mexico. Over the next four years, the price of oil, which had jumped from $4 to $12 per barrel in 1974, soared higher over the next four years to $40 per barrel.
Although many factors contributed to this price per barrel increase, including the perceived supply shortage and the pricing policies of OPEC, and although the case might be made that there was no direct correlation between the creation of the SPR and high price of oil in the 1970s, it is a well known axiom to veteran stock market speculators that the perception of the need for a government “reserve” of anything in general can attribute to the creation of interesting price anomalies in any given market place which in turn offers up money making opportunities. It has happened before and will happen again.
For reasons known only to providence, my need for arcane reading material put the U.S. Defense Authorization Act of 2012 at the top of my holiday reading list. I suppose as a taxpayer, I wanted to see just what I am getting for my money. What I read leads me to believe history is about to repeat itself once again. The United States Government is now in the final steps of setting up a rare earth minerals “reserve” or “inventory” to ensure that our nation has a ready and steady supply for future needs both militarily and industrially.
... Not later than 180 days after the date of the enactment of this Act, the Administrator of the Defense Logistics Agency Strategic Materials shall submit to the Secretary of Defense an assessment of the feasibility and advisability of establishing an inventory of rare earth materials necessary to ensure the long-term availability of such rare earth materials.
The bill continues:
... Provide an analysis of the potential market effects, including effects on the pricing and commercial availability of such rare earth materials, associated with creating such an inventory;
Identify and describe the mechanisms available to the Administrator to make such an inventory accessible, including by purchase, to entities requiring such rare earth materials to support national defense requirements, including producers of end items containing rare earth materials.
The U.S. government has had a mission critical materials stockpile in place since before World War II, but in 2006 a review was conducted and new priorities put into place bringing into focus rare earth materials:
At the direction of Congress in 2006, DoD initiated a review of the NDS led by the Office of the Secretary of Defense (OSD). The results of that review, presented in an April 2009 report to Congress, included a plan for establishing a comprehensive Strategic Materials Security Management System (SMSMS) that would identify, on an ongoing basis, those strategic and critical materials required for national security (OSD 2009).
The Strategic Military Stockpile Program (SMSP) concept would include limited physical stockpiles used in conjunction with friendly nation agreements and long-term supply chain partnerships to provide assurances for military equipment manufacturers regarding material price and availability. The OSD report also recommended holding physical reserves of 13 materials (including cobalt) while continuing to monitor and study 40 other materials (including gallium, indium, tellurium and yttrium).
The Defense Authorization Act of 2012 appears to be the final piece of the government puzzle needed to kick off the program. Interestingly enough, the same DOE report noting the need for a stockpile strategy also cautions the use of such a strategy for certain applications due to potential pricing anomalies in the marketplace:
Based on preliminary analysis, this strategy does not recommend stockpiling critical materials for potential use in commercial clean energy technologies at this time. The demand projections for material use in clean energy technologies presented earlier in the strategy highlight the difficulties in accurately forecasting material requirements due to uncertainties in market conditions, choice of component technologies among manufacturers and competing demands. From a practical standpoint, these factors would make it difficult to develop a national industrial stockpile with sufficient material stocks and flexibility. Even if material requirements could be calculated with a reasonable degree of certainty, the U.S. government would incur significant upfront costs and downside risk to develop a stockpile sufficient to meet domestic material demand.
Maintaining a national stockpile would also put the government at risk of distorting market price signals for key materials by competing with the private sector for materials on the open market. However, given the demonstrated interest of other nations, such as China, in stockpiling, this issue merits further study.
“Significant upfront costs” is the key phrase that investors and or speculators may wish to pay attention to. Once it is publicly announced in the mainstream media that the U.S. government is stockpiling rare earth materials, there will likely be a stampede of investors looking to get in on what insiders such as Goldman Sachs (NYSE:GS) have known was coming down the pike for years. Goldman Sachs was an early-stage investor in Molycorp (MCP) prior to it becoming a public corporation. Goldman would now have investors believe that the rare earth metals market will be marked by oversupply conditions going into 2012.
Others analysts and experts in the field do not believe this to be the case and some openly scoff at Goldman’s analysis. Jack Lifton, writing for Technology Metals Research, states: “I sincerely wonder if this is even good nonsense.”
According to Lifton, one can make the case that there may soon be a shortage in the supply of rare earth materials due in part to demand and in part to the complexities of actually producing the material in paying quantities in a manner suitable to environmental authorities. Plus, other nations and political bodies such as Japan, Korea, The Netherlands and the European Union are taking similar steps as the U.S. to ensure reliable sourcing of rare earth materials for future needs.
There are very few investment vehicles by which the speculator in rare earth minerals may place bets. Other than Molycorp, Titanium Metals Corporation (TIE) and a few obscure Canadian and Australian mining companies, there are few ways for the average U.S. investor to enter this market.
Only two funds invest in the rare earth minerals market. One is the publicly traded Market Vectors ETF REMX that attempts to replicate the Market Vectors Rare Earth/Strategic Metals Index and the other is a private Swiss REE Fund that makes itself available to so-called high net worth individuals. Whenever I run across investment vehicles that set up barriers to entry, I become immediately suspicious and wonder why the common man does not deserve a shot at it. In most cases, such investments are usually obscured in order to avoid regulatory scrutiny or to provide the silver-spooned investor an upper crust platter to eat off of at an exorbitant price replete with extraordinary fees. Thus, I’ll stick with REMX.
In the case of REMX and Molycorp, they have been available to investors for a relatively short period of time. And it is also notable as to how quickly many analysts have written both them and the industry off as if the rare earth mineral space is no longer a viable place for investors to make money.
The fact that oil hit $148 a barrel back in the summer of 2008 does not make oil any less valuable to oil speculators, and I doubt that rare earth mineral investors intend to change the name of rare to common anytime soon. The stock charts of Molycorp and REMX both reflect the bubble commodity conditions of the past couple of years and the irrational exuberance on the part of investors who jumped in when Goldman Sachs and the big boys were getting out. For the rational investor and speculator alike, now may be the time to pick up a few shares for the long haul.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.