China’s Transitory Rare Earth Element (REE) Monopoly

Now that QE2 being announced at the next FOMC meeting is a given, we see potential for short-term position covering in short USD positions and profit-taking in surging emerging as well as commodity markets. While this is happening, JPY could pull back from 15-year highs and give Japanese equities some breathing room for a relief rally. However, a run back above 11,000 on the Nikkei by next February may be too much to expect, as we just don’t see any sustainable reversal in the race to the bottom for US treasury yields as well as the great shrinkage in US-Japan long bond yields that would support a sustained rally in Japanese equities. Consequently, the trade is buy more emerging market equities and commodities on this possible pullback, and take profits as Japan equities stage a brief relative performance rebound.

The sharp curtailment of rare earth elements (REE) by China has highlighted just how dependent technology-intensive western nations are on what is still a relatively tiny basic materials market of only around $1.2 billion. Be it for environmental considerations as China claims or the desire to save these materials for its own consumption, China’s sharp cutbacks in exports of rare earth elements has market prices of these materials soaring. The faster market prices rise, the sooner China loses is current monopoly on supply, as there is no shortage of potential supply of these “rare”elements.

The two names most mentioned as REE plays are Molycorp Minerals（MCP）, owner of the Mountain Pass mine in the U.S. and Lynas Corp. (LYSCF.PK), owner of the Mount Weld mine in Australia, which combined can supply 25%‾30% of global supply when fully operational. Investors however need to be aware that both stocks have tripled in price since June‾July of this year on the news that China has substantially cut back REE exports, while operations are still deeply in the red. As other REE plays essentially have no product to sell as yet and may not for many years, we view such stocks as speculative plays with little fundamental support at present. In Japan Showa Denko (4004) and Hitachi Chemical (4217) are key suppliers of ceria surry, but this business is too small to dramatically turn around total revenues or earnings even if prices of REE materials are jacked up as much as 300%. Consequently, stock prices have followed the general market for Japanese equities, i.e., steadily waffling lower since April 2010 highs.