Donald Trump's recent remark that as president he would ensure that Apple (NASDAQ:AAPL) produces its products in the United States is laughable: we don't think this is possible, nor than it can be in the foreseeable future. Trump's sentiment is that excessive regulation makes it too expensive for the company to manufacture its products in the US. There may be some truth in that, but this is the least of Apple's reasons for sourcing so many of its components from the rest of the world, and China in particular. The following map quantifies Apple's suppliers by country.
Apple could not possibly produce its "damn computers and things" without critical value-add steps taking place in China because certain core inputs are almost exclusively produced in China. This production can't simply be replicated here because we haven't yet developed the processing value chain or intellectual capacity needed to carry it out as efficiently as they have. Every computer and phone contains parts that include high strength permanent magnets - most of which are produced in China. Chinese firms (many of which are controlled by the State) produce the vast majority of the rare earth elements ("REEs") that are needed to produce these magnets, and they control the chemical processing capabilities required to produce them.
China's share in these categories has not since changed materially.
The Chinese have a disproportionate amount of REE reserves, perhaps giving them an "unfair" advantage, but this along with high U.S. wages and excessive regulation cannot explain the relative appeal of manufacturing in China as opposed to the United States. The Chinese have been consciously developing the "mine-to-magnet" value chain (as Mark Smith - former CEO of Molycorp (OTCPK:MCPIQ) - put it) over a period of decades, and they are consequently in a position in which China has a material advantage over just about any other competing nation. This advantage differs from the others in that it cannot be legislated or funded out of existence.
REEs and rare earth magnets ("REMs") are ubiquitous in today's high-tech products, making them highly strategic: governments and manufacturers that cannot get their hands on them are at a disadvantage to those that can. Chinese central planners came to this realization long before those of the Western world, and as a result it made shrewd decisions that in part account for China's dominant role in global manufacturing of high-tech products.
The Chinese attempted to acquire Molycorp's Mountain Pass in 2005 through CNOOC (NYSE:CEO) although regulators got in the way. The Chinese attempted to acquire Lynas (OTCPK:LYSDY) in 2009 but walked away when Australian regulators mandated that the Chinese stake remain below 50%. The fact that they walked away suggests that they were less interested in the potential capital gains through an equity position in Lynas and more interested in maintaining control over global REE production.
The Chinese acquired U.S.-based Magnequench in 1995. Magnequench was a branch of General Motors (NYSE:GM) which was set up after the company co-invented the neodymium-iron-boron magnets that today are so critical to modern industry. Regulators recognized the asset's strategic significance and so they mandated that the Chinese maintain the facility in the United States for five years. But the short-term thinking of today's U.S. politicians and bureaucrats is no match for the long-term planning we see from Chinese politicians who don't need to worry about election cycles. After five years the Chinese shut down Magnequench and moved the entire operation to China, giving it access to the equipment and intellectual property that led them to dominate this part of the value chain as well.
And recently, the Chinese firm Jien Mining had intent to invest in Northern Minerals (OTC:NOURF). It has since backed off, considering that Chinese domestic producers overproduce the particular REEs found in Northern's Browns Range deposit (namely terbium, dysprosium and yttrium).
Thus we see a clear pattern of the Chinese working toward controlling as much of the REE and REM industries outside of China as possible. At this time there is only one major REE operation outside of China - nobody else is even close.
The United States is just beginning to respond, although hardly with urgency. We've begun to see some research into these issues at the federal level (c.f. Grasso, Humphries). We've also seen the Defense Logistics Agency begin to stockpile dysprosium and high purity yttrium. The former is a critical input for Nd-Fe-B magnets and is produced almost exclusively in China, while the latter will be used in yttrium aluminum garnet lasers.
With respect to production and actual REE project development we've seen some initiative, yet no encouraging results.
- Ames Lab (the Department of Energy) did work with Molycorp to research the manufacture of REMs.
- The Department of Defense contracted with a company to do research on its REE project according to the company's 2012 PR, although the specific aim of the study isn't clear and we've since seen no follow-up.
- The Army Research Laboratory gave money to a company working on REE metallurgy for commercial application and we have seen no follow-up.
- The Defense Logistics Agency is working with another company to produce high purity REEs that will have niche yet critical applications in the defense industry.
- The Department of Energy has found companies to do research on recovering REEs from fly-ash from coal mine tailings.
While we are seeing some initiative, we've also seen how the government may be stymieing the industry in other ways. For instance permitting a mine in the United States is costly and time consuming. In fact one company just cited permitting delays as a reason for slowing down project development and slashing expenditures. Other companies that are less advanced have this to look forward to, especially if they are developing projects on federal land.
The Bottom Line
While Trump and other anti-China protectionists would like to see Apple produce its "damn computers and things" in the U.S. this is effectively impossible, save for the final assembly steps which add very little value. The sentiment may ring true, and it may generate traction with some voters, but the problem is logistics, materials and intellectual rather than political in nature. This means it cannot be solved overnight with legislative action, and Apple and its suppliers will continue to build the primary inputs for its products in China.
*Investors are encouraged to read our recent article: We're Exceedingly Bullish Of Rare Earths.
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