The precipitous decline of rare earth prices since September seems to, at least temporarily, have put a damper on the hype that had been building over the past few years. The relative calm provides a good opportunity to reflect on the recent evolution of the rare earth element (REE) industry and, as I see it, some prevailing misconceptions that have been driving the industry since 2009.
Background: Enter Investors and the Media
REE's entrance into the investment community's spotlight brought with it previously unthinkable levels of media coverage. What was once a colloquial industry quickly became the topic for resource investors, as the drastic cuts to China's rare earth export quotas caught the attention of not only business reports, but also political analysts and technology reports. Even National Geographic couldn't turn away from the story of REEs, which formed a 'perfect storm' of high trending news topics: geopolitical confrontation, China, national defense and green technologies, energy dependency and, of course, investment opportunities.
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Chart c/o Metal-Pages.com |
Unfortunately, the sudden influx of interest in REEs created a void of persons with expertise in the elements themselves. Global production having, in effect, completely moved to China during the three decades prior, few in the West were knowledgeable of both the production (supply) and end-uses (demand) to effectively comment on and analyze the developments. The media was left wonting for information and, so, turned to any individuals and companies with involvement in the industry; traders, investors and exploration and development companies.
The major problem with this was that the vast majority of players within these groups had vested interests in promoting the demand potential for REEs, as well as the supply side risks of Chinese REEs. There was - and continues to be - little incentive to dispel sensational reports that China will cut off all supply of REEs to the West or that REEs are the battlefield for a geopolitical war over green technologies.
The herd of investors and commentators has grown daily over the past two years, while the few balanced analyses produced during this time have been lost amongst more alluring headlines calling for REE stockpiles, national REE 'strategies', subsidies for domestic production and REE self-sufficiency; common nationalistic responses that have been seen in other resource industries suffering from supply shocks, but which have been proven more or less ineffective in actually impacting long-term supply constraints.
Complexities and Misconceptions
To be fair, however, the changes began so quickly, in an industry that wasn't used to fast-paced change, that it was difficult for anyone to evaluate exactly what the next direction would be.
The fact is that REEs are a complicated group of elements. The issues involving extractive metallurgy, ore types, radioactivity and technical separation capabilities do not fit well into the normal 300-word news report or blog post. And, as mentioned, after 20-plus years of dependence on Chinese production, there were very few with the technical background to effectively evaluate the potential for non-Chinese REE production (which is one reason why I have stayed far from attempting any such analysis).
Moreover, just as the production and separation of REEs is a far more complex issue than media coverage has portrayed, so are the industry demand-side dynamics. The ever-changing influence of Chinese export taxes and quotas, the diverse and evolving end-use applications, as well as the potential affects of substitution may have been examined, but have not necessarily been understood.
One of the core components of media reports on REEs - and one that I believe has been at the heart of prevailing misconceptions - is the myth of substitutability; that REE end-use applications are so unique that nothing can replace these elements.
The focus of media reports and the recently arrived financial community has overwhelmingly been on national defense and high-tech applications or energy and green technology. Most commentators - traders, investors, blogs and mining companies - have, consciously or not, been quite happy to continue pushing this concept. Do a web search of articles on REEs and you will likely come across the countless references to wind turbines and electric cars, but you would be hard-pressed to find any discussion of fluid cracking catalysts, glass decolorizers or water treatment; REE end-use consumers that have, for years, been accustomed to buying large quantities of subsidized REE chemicals for just a few dollars per kilogram.
However, these industries, that have made-up a significant core of REE demand for the past 10-20 years, will, without question, be the focus of attention in the coming year. That is because, after initial complaints about the spike in prices, large quantity REE end-users got down to work, looking for ways to cut back on their consumption and substitute previously cheap, plentiful REEs. How much success they have had should become more apparent in the coming months and will likely have a strong bearing on the market's direction in 2012, and beyond.
The second misconception that I believe has pushed prices higher is that the carbon-based economy of fossil fuels has come to an end. A misbelief that is fueled by statistics suggesting that we will all be driving electric cars and lighting our homes with electricity from wind farms within a matter of years.
Perhaps I shouldn't call it a misconception. We may be on the cusp of a green economy, I really couldn't tell you; but what I do know is that we are not there yet. And, in the meantime, REEs continue to be produced at near record levels. With the substitution and consumption adjustments brought on by skyrocketing prices, the recent plunge in prices is likely evidence that fears of massive shortages have subsided.
As it stands, despite Chinese efforts to keep prices at record levels, material is more plentiful than demand and prices continue to slide.
Speculators: Are They Bored Yet?
The other factor that has had a significant impact on the industry since 2009 and should not be overlooked is the exponential growth of investment and speculation. To be clear, there is a difference between the two: Investors are companies and individuals who have invested funds into the production of REEs. For the most part, this has been directed into potential producers outside of China. Speculators, on the other hand, are individuals and companies that are buying material betting on further price increases.
Although these two groups, under most circumstances, may be discussed separately, likely due to the tempting returns, there has become overlap between REE investment and REE speculation. Increased investment in capacity is part of the normal evolution of any resource industry. But the effect of speculation is more debatable. In the long-term, the effects of speculation on prices may be minimal, but in the short-term - particularly in smaller markets - speculation can play a large role in price determination. Since 2009, the REE market has been strongly influenced by both public and private speculation, which has held material (and export quotas) from the market and further driven price increases.
The question is whether this investment is going to stick around, in which case the industry will have to adjust to this new form of demand, or whether it is just a temporary phenomenon, hoping to capitalize on potentially large returns. What comes next is up to investors and speculators. Will investors keep putting their money in companies that will come under increasing pressures from lower market prices and decreased demand due to substitution and replacement, and will speculators keep holding their inventory, or cut their losses and release material into the market? I hazard to guess that if the world of electric and wind turbines is not just around the corner, then investors will move on to something newer and shinier.
This is not to say that REE prices are coming down to where they were 5 years ago. The Chinese supply that has been cut from the market is not returning and, for the time-being at least, speculators remain in the market, holding material and hoping that more export cuts drive up prices again.
What can be expected is that recent efforts by China and Chinese producers to stem the bleeding prices will continue and likely stabilize the market by early 2012. But the real test will be in the first half of 2012. Only then will we begin to see; (1) how much demand has been taken from the market due to substituting and lower consumption, and (2), the patience of speculators over how much risk (loss) they are willing to take before moving on.
-Terence Bell
Strategic Metal Investments Ltd.
Looking Back: The Evolution of the Rare Earth Industry (2009-2011) - Strategic Metal Report
Posted by: Toms Sale | 08/16/2013 at 04:15 AM