China Trade - Invest Based On Rare Earth Price Hikes

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Includes: BAESY, GD, LMT, MU, NOC, STX
by: Robert Castellano
Summary

The U.S.-China trade war may escalate to include an embargo by the Chinese on rare earth materials used in commercial and defense applications.

A previous embargo between China and Japan in 2010 resulted in the price of rare earth materials from China increasing more than 600% in 2011.

Prices of rare earth materials rose nearly 50% in May 2019, based on merely the rumor of another embargo.

Over the past week, there have been a flurry of reports in the media that may restrict the export of rare earth minerals to the United States as the trade conflict between the two countries escalates.

Eleven months ago, I anticipated that the nascent China trade dispute would eventually bring rare earth minerals to the fore. On June 28, 2018, I wrote a Seeking Alpha article entitled, “A New China Rare Earth Embargo Would Damage Several U.S. Companies' Technology Competitiveness.”

I emphasized in the summary bullets for the article:

  • The U.S. and China are embroiled in a trade dispute, and the Chinese could readily impose a tariff on rare earth elements as it did in 2010.
  • China supplies between 85% and 95% of global demand for the 17 rare earth powders and metals used in high-tech applications such as smartphones, catalysts, LED screens and polishing.
  • U.S. companies whose products incorporate rare earth materials would be at a competitive disadvantage if the Chinese were to impose a rare earth tariff.

I refer readers of this visionary article to the companies and applications that I discussed in that article, which I summarize in Table 1. Also, eight years earlier, on November 5, 2010, I wrote a Seeking Alpha article entitled, “How China's Rare Earth Embargo Impacts High Tech Companies,” and I refer readers to my discussion on applications for semiconductor companies.

Table 1 links several companies and the rare earth materials they use in their products. But there are many more applications, both high-tech and non-technical, which I list in Table 2. Any one of these applications will impact a company importing finished rare earth-based products from China.

Implementation of an embargo can weigh heavily on U.S. industries, as listed in Tables 1 and 2. This would not be the first time China limited exports of rare earth minerals. Back in 2010, Japan detained a Chinese fishing boat skipper whose trawler collided with two Japan Coast Guard ships near uninhabited islands in the East China Sea that both sides claimed.

An embargo of rare earth minerals by China restricted exports and resulted in skyrocketing prices. Shown in Chart 1 and 2 are prices for neodymium and cerium before, during and after the embargo, according to The Information Network’s report entitled, “Rare Earths Elements in High-Tech Industries: Market Analysis and Forecasts Amid China’s Trade Embargo.”

Chart 1

Chart 2

Critical Issues

The U.S. has essentially no domestic production of rare earth minerals nor facilities to purify the minerals into metals. In 1998, the US National Defense Stockpile sold the entire strategic reserve of rare earths. The same year, the last U.S. producer of rare earth metals and alloys, Rhodia Incorporated, closed its processing facility in Texas and built a new one in Mongolia.

MP Materials, which runs the Mountain Pass rare earths mine, America’s sole rare earths mine, will kick-start its own processing operation by the end of 2020. MP exports pellets - ground-up ores that contain oxides of rare earth elements - to China for processing into neodymium, cerium and other elements used in magnets, electric vehicles, smartphones and a myriad of industrial applications and electronic products.

The deposits at Mountain Pass, discovered in 1949, contain cerium, lanthanum, neodymium and europium. It was exploited by Molycorp for more than half a century until the company filed for bankruptcy in 2015, as tight environmental laws in California made the processing of rare earths - a highly polluting and potentially radioactive process - commercially non-viable.

And therein lies the problem - there is one domestic supplier, and that company sends the minerals from the mine back to China for processing. Some activity is underway to establish refineries in North America. Defense Metals Corp., a British Columbia company, is aiming to bring a deposit of rare earths into production. A pilot refining plant is planned, but the company is funded only for the initial testing stages.

China was able to dramatically impact the REE prices because the country excavated more than 90 percent of rare earth elements produced in the world in 2010. Then, it acquired nearly all of the ability for processing the rare earth ore into end products.

These processing capabilities include:

  • Separating the rare earth ore into individual rare earth oxides;
  • Refining the rare earth oxides into metals with different purity levels;
  • Forming the metals into rare earth alloys; and
  • Manufacturing the alloys into components, such as permanent magnets, used in defense and commercial applications.

In other words, even if there are alternative sources of rare earth minerals mined in the U.S, there are no sizeable refineries for converting the rare earths from rock to separated elements. Currently, the only sizable producer of rare earth materials outside China is Lynas, an Australian mining and refining company that supplies around 12% of global output.

Rare Earths for Defense

Defense contractors BAE Systems (OTCPK:BAESY), Northrup Grumman (NOC), General Dynamics (GD) and Lockheed Martin (LMT) are among those that would be impacted by a rare earth embargo. According to Reuters, the U.S. Defense Department is seeking new federal funds to bolster domestic production of rare earth minerals and reduce dependence on China, recently submitting a Defense Production Act III rare earth mineral report to Congress.

Rare earth metals are used in commercial and defense applications. For example, the directional capabilities of precision-guided munitions in missiles and guided bombs rely on rare earth materials, as do lasers used in target interrogators, target designators and rangefinders. Rare earth materials are also found in electronic counter measures, coatings, optical equipment, as well as in the electrical systems in aircraft, which use samarium-cobalt permanent magnets to generate power.

Virginian-class nuclear-powered submarines each use 9,200 pounds of rare earth metals, while Arleigh Burke guided missile destroyers require about 5,200 lbs of rare earth metals - there are 66 destroyers in service and 14 either under construction or on order.

The F-35 Joint Strike Fighters each requires 920 lbs of rare earth metals - 380 have been built so far, and the total buy for the US alone is 2,663 aircraft, with Japan now about to order an additional 105 F-35s.

Investor Takeaway

Much has happened since the Chinese rare earth embargo in 2010:

China has by far been the largest source of imported rare earths into the US for a number of years, totaling almost $92 million in 2018, according to the US International Trade Commission. But Japan, the U.S.’s second-largest source, contributed $23 million worth of imports in the same year. So, there are key suppliers of rare earth materials outside of China. Large Japanese companies Shin-Etsu, Hitachi Chemical and TDK (TTDYK) supply Nd magnets to customers in the U.S.

Secondly, there have been sources of rare earths in development outside China. Japan has discovered huge deposits of rare earth materials at Minamitori Island (Minami-Tori-shima), about 1,150 miles (1,850 km) southeast of Tokyo. The estimate of the Minamitori deposits indicates that there is enough yttrium to meet the global demand for 780 years, dysprosium for 730 years, europium for 620 years and terbium for 420 years. U.S. policymakers could seek a partnership with Japan in commercializing Minamitori’s rare earth resources and arranging assured supplies for defense and vital commercial applications.

Thirdly, the U.S. government appears to be placing trade restrictions based on security concerns, such as the Huawei ban. In 2016, and based on the embargo of 2010, the US Government Accountability Office, an independent, non-partisan agency, warned that China’s dominance “may pose risks to the continued availability” of rare earth materials for defense applications in the future. So, I am assuming that in the past three years, and certainly with this current administration for the past two years, the government has been stockpiling rare earth materials.

But one thing remains the same between 2010 and 2019 - rare earth price increases. Investors need to consider when playing the market that rare earth prices will rise. Already, prices have been rising just based on the rumor of a rare earth embargo. Chart 3 shows that on May 30, 2019, rare earth Dysprosium Oxide closed at $353.4/kilogram. On May 1, before the rumors came to light, Dy was trading at $246.5. That’s a 43% jump in one month and based on rumors alone.

Chart 3

Investors should invest in those companies in the rare earth supply chain. I refer readers to a list of stocks provided by Outsider Club.

Keep in mind that the high prices of rare earths will impact prices of items utilizing them. For example, the weight of rare earth in an EV is approximately 1 kg (2.2 lbs), meaning that the price of rare earths is approximately $150 per EV. If prices quadruple like they did in 2011, that increase would raise the EV price approximately $450, approximately 1% of the MSRP of the vehicle.

A savvy investor will recognize that HDDs contain Neodymium magnets, and cerium oxide is used as a slurry to polish glass disks inside the housing. As a result, HDD prices should rise, impacting Seagate Technology (STX) but benefiting NAND suppliers such as Micron Technology (MU), which makes memory chips that compete against HDDs.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.