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How in the world did we come to this point with rare earth supply fears?

Jan. 10, 2011 8:34 PM ETREMX, REE-OLD, GMO
Jeb Handwerger profile picture
Jeb Handwerger's Blog
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 History is replete with seemingly unexpected and catastrophic appearances of events that nobody saw coming. In the old days, we had biblical prophets who sounded clarion alarms. Now we are past the age of prophecy. As in historical watersheds, we suddenly find ourselves congealed in the volcanic ash of a modern Vesuvius eruption, which leads us to scratch our heads and ask: How in the world did we come to this point with rare earth supply fears? Where were all the environmentalists who are aware of how rare earths are used in clean energy? Where were the technology companies whose profitable patents are dependent upon rare earths? Did not the most scholarly minds at our most eminent universities hear the honking of the black swans? I guess not. Our academicians, business leaders, and legislators were enjoying their own Rip Van Winkle reveries, while the Chinese were wide awake co-opting the rare earth arena, taking control of over 97% of the world’s supply.

It is easy to accuse the Chinese of using rare earth quotas as a form of tactical diplomacy. However, the fault lies not in the stars but in ourselves. We closed our rare earth production facilities years ago -- in effect, forfeiting the very means of manufacture to a competitor giant who no longer is sleeping. Now they can claim that they are setting up quotas so they can prioritize their own domestic needs. In reality, highly profitable technologies are dependent upon the use of the 17 unique elements, and China is trying to get a larger share of the mobile, computer, and green technologies -- especially now as the country begins preparing for an economic slowdown from hawkish monetary policies.

Since November, China has shown an inverted V top and is now failing at the 50-day moving average, for the second time in danger of crashing through the 200-day moving average. Wars are no longer fought on battlefields, they are fought in boardrooms. Now China wants to take advantage of its 20-plus years of being the sole provider of heavy rare earths and monopolize a commodity whose demand is growing rapidly. 

China, at one point, looked abroad for rare earth projects and may start doing so again. Recent legislation in the US may bring more of a domestic awareness, but it is very late. Many of these mines outside China are years away from development, especially the critical heavy rare earths in which there is no separation facility outside of China.

The United States, for all its vaunted scientific know-how, with all its battalions of university savants, long ago left the heavy lifting to China. It reminds me of Rome who invited the Visigoths to enter the gates. 

We are akin to a nation of Sonny Listons who never saw Ali’s knockout punch coming. It may be hindsight to accuse our politicians and our leaders of malfeasance, of not understanding the vital need of these elements by our industrial giants in the latest cutting-edge technologies (think Apple (AAPL) and its iPhones and iPads, GE (GE) and its wind turbines, and GM (GM) and its hybrid cars and numerous applications in the US defense industry such as night-vision). Meanwhile, our nation careens, blindly seeking the way out of this morass. Sadly, we must reenter a race which once was ours to win. Decades ago we were the major developers of rare earth technology; we now find ourselves four to five years behind. 

Of the many contestants in the rare earth sector, there are perhaps one or two who are close to the finish line in producing outside China. Investing in rare earth mining is completely different than investing in gold or silver. Rare earths become quite costly during the separation process and very few projects are economically viable. The mania phase is upon us, and investors get caught up with all the speculative rare earths promising a dream. I would stick only to the ones that are advanced and have at least a 43-101 compliant prefeasibility study. In late December 2010, I came out with a report on rare earths as I saw signs of an immediate cut in quotas (see Rare Earths About to Get Even Rarer). Notice the huge volume coming in to rare earths stocks immediately after the export quota reduction. Long-term investors might want to wait for a secondary buy point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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