China restricts raw earths again – Boom time for specialist stocks? Will it hurt global manufacturers?

19th June 2011

China, the world's most important source of rare earths is using the metals to fire its own manufacturing industry, restricting imports and enforcing better environmental regulations. This has seen prices of key rare earths rocket in the last few weeks.

Though stock prices of rare earth firms come in and out of favour – only a few weeks ago they were suffering a significant correction over fears of an economic downturn- China's moves to restrict the market may well send prices higher again. Indeed China may actually ban the export of some rare earths by 2015.

Many are in no doubt of their importance. Here Daily Mail reporter, Richard Jones believes he is the first Western journalist to visit Baiyon Obo, the largest rare earth mine in the world, in China's Inner Mongolia. A worker smuggled him into the mine. This report has the pictures to prove it. 

He writes: "The rare-earths blasted out of rocks here feed more than 77 per cent of global demand for elements such as terbium, which power low-energy lightbulbs; neodymium, which powers wind turbines; and lanthanum, which powers the batteries of hybrid cars such as the Toyota Prius.

"They are also used in mobile phones, computers, iPods, LCD screens, washing machines, digital cameras and X-ray machines, as well as missile guidance systems and even space rockets. Industries reliant on the rare-earths are estimated to be worth an astonishing £3trillion, or five per cent of global GDP."

Jones mentions the poisonous acids that China uses to extract the minerals from the ground, but China is aiming to improve environmental standards as specialist website Industrial Minerals reports here.

As the magazine reports it is not just the fact that China is tightening its environmental regulations – it is also one of the few countries that can mine, process and refine the minerals from start to finish.

This weekend's Observer reports on the actual price rises here.

It writes: "Europium oxide, an element with phosphorescent properties used in energy-saving light bulbs, plasma TVs and smart phones, has nearly tripled from about $1,260 a kilogram to a record $3,400.

"Dysprosium oxide, a key additive used in the neodymium-iron-boron magnets found in computer hard drives and wind turbines, doubled from about $720 a kg to a record $1,470 over the same period. That follows a near tenfold rise in the price of dysprosium oxide in the year to June."

Investment play?

Oil and commodities website advises its readers to keep an eye on prices of Canada-listed Avalon Rare Metals, one of those firms with access to significant deposits outside of China and suggests buying on the dips here.

Earlier this month, on Seeking Alpha Dr Stephen Leeb considers both Avalon and Quest Rare Minerals. 

He writes: "The two most significant non-Chinese deposits of heavy rare earths – which are the ones that really count because they are needed for magnets that are used in everything from wind turbines to defense equipment – are in Canada. One is Avalon Rare Metals (AVL); the other is Quest Rare Minerals (QRM). These are small companies, with a combined market value of about $800 million, which means most mutual funds can't even look at them. They're also unabashedly speculative investments."

Leeb however is very concerned that America's lack of these resources could prove crucial in preventing it from maintaining a decent standard of living.

From earlier this year, however, Seeking Alpha contributor Rougemont was not so sure suggesting that all the talk of rare earth stocks on the hugely influential business TV channel in America CNBC meant very high price to earnings ratio which can show a stock is overvalued. He also suggests the stocks might be attracting momentum investors i.e. investors buying at least partly due to market demand rather than fundamentals.

This article was penned in April but some of its lessons may be worth applying before investing.

In fact, rare earth related stocks have seen something of a market correction in May and June as discussed here's Tom Aspray though he sees some buying opportunities too.

Will it impact big manufacturing companies more generally?

Writing in 2010, warned about rare earth prices could stifle innovation. 

However this is an interesting quote in Resource Investor from Jon Hykawy, head of global research with Toronto-based Byron Capital Markets. He says: "[These materials are] critical to someone, to some task at some point in time. You can have an industry dependent on metals that are relatively common but if the downstream dependence is strong enough, you can have a significant impact on revenues in a much-larger industry with something that really isn't worth all that much. A good example of that would be dysprosium. Dysprosium is becoming more expensive per kilogram but the world market for it is still tiny. Yet without it, you can't build permanent rare earth magnets that work at high tempe
ratures. And without being able to do that, you're not going to commit to the manufacture of those magnets and the manufacture of motorized vehicles that are dependent on motors containing those magnets. So, we put dysprosium on the critical materials list because with a lack of that you're basically impacting a large automotive sector."

Hykawy does note however that some manufacturers have told him that while creating an electric car without rare earths is difficult it is nigh on impossible without copper. So commodities do not need to be ‘rare' to be significant.

Whatever their dependence, some big manufacturers are aiming to hedge the risk.

This report from Electric Forum earlier in the year shows that some car firms are trying to avoid rare earths altogether with Toyota working on a hybrid engine which does not use them with help with electric car specialist Tesla, which is also avoids any reliance on rare earths in its electric cars.

Further reading:

The excerpt from an FT book called "Buying at the Point of Maximum Pessimism: A Rare Opportunity" by portfolio manager Scott Phillips covers the rare earth issue.

The UK Parliamentary Office of Science and Technology published a report on the issue earlier this year here.

The American Security Project issues a report here warning that America's dependence on Chinese rare earths represents a national security threat.

Here Forbes reports on the likely presence of a huge amount of rare earth deposits in Afghanistan.

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