Rare Earth Elements and The China Growth Story
by David Fessler, Senior Analyst, Investment U
Tuesday, August 16, 2011: Issue #1579
The average U.S. household owns hundreds of Chinese-manufactured goods. Almost the entire apparel industry moved out of the United States and halfway around the world. Most of our electronics, a lot of our food, and many of our automobile parts come from China.
Two of my friends own companies that previously had manufacturing plants in the United States. Over the past several years, both moved their manufacturing operations to China.
Countless numbers of industries also moved their operations offshore. Some of them moved or opened plants there to take advantage of the fast-growing Chinese economy.
Caterpillar has more than 27 manufacturing operations in China. General Motors makes and sells automobiles within the country. That’s a mix of good news and bad news.
- The good news is that companies can reduce their manufacturing costs.
- The bad news is that it comes largely at the expense of the American worker who loses a job to the Chinese counterpart.
Incredibly, the worst part of the China migration has nothing to do with anything I just mentioned. But it's so critical, it will affect the ability of the United States to defend itself in the future...
Indebted to China for Our Nation's Defense
Many view it as a stroke of genius on the part of China. Others view it as the United States being caught off guard.
Some of the most critical components in some of the most advanced military hardware in the world (ours) depend on China.
I’m talking about lasers and magnets embedded in some of our most advanced weapons and early warnings and tracking systems.
How can China possibly be involved in these systems, you ask?
Three words: rare earth elements (REEs)...
China's Continued Monopoly on Rare Earth Elements
As is now commonly known, China owns a monopoly in REE production, controlling as much as 97 percent of global supply, by some estimates.
A few examples of rare earth elements used are:
- Neodymium isn’t just used for powerful magnets in electric vehicle motors and giant wind turbines. It’s used in very small magnets that are part of missile and smart bomb guidance systems. Various spy satellites use it, as well as a new class of hybrid motors being retrofitted on naval vessels.
- Samarium, another REE, is combined with cobalt and used in the guidance systems of Aegis-class submarines and M-1 tanks. And the list goes on: Ytterbium is used in laser guidance systems for some missiles and tanks.
Hard to imagine, isn’t it?
The sad part is that it didn’t need to happen. The United States has the second-largest known global reserves (13 percent) behind China’s (36 percent).
Twenty years ago, we were mining our own REEs right here. Gradually, over a 20-year period, China slowly ramped up its production, cut its REE prices and drove the U.S. REE miners out of business.
Congress Revitalizes Domestic Rare Earth Production
It appears as though Washington bureaucrats are finally recognizing the severity of the situation. Last September, the U.S. Congress passed the Rare Earths and Critical Materials Revitalization Act.
The purpose of the law is to promote research and development into technologies that can replace REEs, as well as support the revival of REE production here in the United States. Additional legislation is also pending in both the House and Senate.
Unfortunately, even if we start right now, according to the Government Accountability Office (GAO), it could take as long as 15 years to establish a mine to magnets supply chain.
It’s all good news for REE producers like California-based Molycorp, Inc. (NYSE: MCP) and Rare Element Resources, Ltd. (AMEX: REE), a Canadian REE miner. Both are scrambling to produce REEs in sufficient quantities to take some of the demand away from China.
It will be a few years until meaningful volumes begin to show up on the market from these producers, as well as others outside of China. Molycorp expects to be producing 20,000 tons annually by the end of 2012.
Even under the most optimistic of circumstances, China will have a stranglehold on the REE market for at least the next several years. Investors who invest now could see windfall profits down the road, particularly if the Chinese tighten supplies even further.