8/8/2019 REM - The Grand Pan Jan Drum and Its Monopoly (Jim Coke)

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Rare Earth Metals the GrandPanjandrum1 and its monopoly

he Melian Dialogue in the great 5 th century BC

classic of Thucydides History of thePeloponnesian War best describes the

context in which one looks at monopolies. The

Athenian argument that the strong do what they canand the weak suffer what they mustis certainly truewhen examining an industry that clearly has nocompetitors or at least none to speak of. And theRare Earth Metals (REM) industry is one where Chinais the monopoly, the strong, and the rest of the worldis the weak (who will suffer what they must). Despitethis gloomy outlook, there are huge potentials andpossibilities for an investor.

T

What are REM?

They are a group of 17 lanthanide transitionelements in the periodic table (classified as either

light or heavy) which have a plethora of usesranging from smart phones to lasers, wind turbines,low energy light bulbs, hybrid cars, precisionweapons and flat screen televisions to name a few.As a matter of fact, green technology could not reallyexist without REM.

Does China really have a global monopoly inREM?

In a word; yes! China controls 95% of total worldwideproduction and known supply of REM2 (100% in thecase of dysprosium and terbium). A single mine in

Baotou, in Chinas Inner Mongolia owned by the aptlynamed Inner Mongolia's Baotou Rare-Earth Co,produces half of the worlds rare earth elements3. Infact, Baotou Steel has even consolidated its positionby launching a unified pricing mechanism with JiangxiCopper Corp in China for light rare earths virtuallycontrolling the whole global light rare earth market.Only as recently as 2002, the Mountain Pass mine inCalifornia was the worlds largest supplier of REM butclosed down in the same year due, primarily, to Chinadriving REM prices down and simply destroyingglobal competition. Having said that, Mountain Passmine plans to reopen in late 2010. India is a very

distant second to China in REM ore production.Deposits are also found in Australia, Greenland andCanada with miniscule production levels.

1An invented phrase in a passage written in 1755 by Samuel Foote, anEnglish actor and dramatist. The Grand Panjandrum is a satirical

reference to something or someone of immense importance.2

Koven, Peter (July 12, 2010) China imposes export quotas on rare

earth elements Financial Post3

Zhou, Yan (August 4, 2010 ) Baotou Steel keen on cornering rare

earth marketChina Daily

Fig. 1 Graph showing global production of REMs4

How come I havent heard of REM from otheradvisors?

Contrary to expectations, REM are not, as their namemight indicate, rare. They are just extremely difficultto invest in. Firstly, unlike precious metals, theycannot be found as a raw commodity traded on alisted exchange anywhere in the world. And it is

unlikely that they will be traded as the Chinesegovernment uses its supply as a geopolitical weapon.An added benefit of its absence on an exchange isthat it means REMs arent subject to speculativetrading and manipulation that is pervasive in preciousmetals. Instead, what is relevant is the interplay ofsupply and demand in a free market economy.

Secondly, until the second quarter of 2010, therewere no passive ETFs to track REM. One notablefund is REE-Fund set up in Switzerland under themine-to-marketapproach (essentially tracking everycompany involved with the mining, refining andmanufacturing of REM). It is armed with a goal tobeat a return target of 12% per annum5. Despite theemergence of the REE-Fund, investors are limited toQualified Investors or High-net-worth individuals(pretty much the same criteria as investing in a hedgefund) almost ruling out the average investor whowants exposure to this potentially critical market.

Finally, the Chinese government has almost made it apriority that REM remains closed to the rest of theworld if ever there was a case of the strong doingwhat they can and the weak suffering what they must,this is certainly it. Chinas emergence should come asno surprise as former Communist Party leader Deng

Xiaoping is reputed to have remarked in 1997, Thereis oil in the Middle East, there are rare-earths inChina; we must take full advantage of this resource.6

4Fessler, David (October 22, 2009) Three junior rare earth minersfor the brave MoneyWeek5www.ree-fund.com

6Heap, Tom (May 19, 2010) Why China holds rare cards in the race

to go green www.bbc.co.uk/news/

http://www.ree-fund.com/http://www.ree-fund.com/http://www.bbc.co.uk/news/http://www.ree-fund.com/http://www.bbc.co.uk/news/

8/8/2019 REM - The Grand Pan Jan Drum and Its Monopoly (Jim Coke)

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What this means is that China has a strangle hold onREM with the ability to depress prices if otherproducers enter the market and then limit supply tocreate a demand artificially. As recently as the thirdquarter of 2010, China cut export quotas of REM by72% for the second half of the year despite vociferousobjections by the United States and Europe.7

In summary, REM are too elusive, illiquid and have

dangerously high political risk for any serious investorto make it part of an investment portfolio. Or arethey?

Why REM might be perfect for your portfolio

Commodities are the perfect diversification asset andin the troughs and peaks of an economic cycle, theirreturns are divergent from the traditional assetclasses i.e. equities and bonds. Investing incommodities will not only diversify a balancedportfolio but will push the return distribution to the leftgiving it a positive skew and excess kurtosis8. In other

words, an investor is likely to see positive returnswhen the stock market is down and interests ratesare low. Sounds familiar?

Support for this proposition can be seen in the rise ofcommodity prices since the Credit Crunch and thehighs of precious and industrial metals in the last 12months. REM, in particular, can give returns far inexcess of other commodities precisely for the samereasons that cause it to have high political risk; supplyis being artificially manipulated thereby creating aperfect monopoly. With no known competitors, bothin the supply line of the commodity and as a

substitute component in the green technologyindustry, REM appear unassailable.

How do I invest in REMs?

The straight forward answer to this question is onlyinvest in Chinese REM mining companies of whichthere are less than a dozen listed on stock exchangesaround the world. The risk of China suppressingprices to destroy global competition is too great toignore and too easy to accomplish. Hence, looking atnon-Chinese companies for REM returns is fraughtwith the danger of being caught in a trade warbetween the worlds hyperpower9 (the U.S.) and its

next superpower (China). If or when REM becomesthe raison d'tre for a trade confrontation between

7Xiao, Yu (July 9, 2010 ) China cuts rare earth export quota 72%, may

spark trade dispute with the U.S. Bloomberg News8

Skewness is a statistical measure that characterizes the degree of

asymmetry of a distribution around its mean and kurtosis characterizes the

relative peak or flatness of a distribution compared to a normal

distribution.9

Hyperpower was a term coined by the former French Foreign Minister

Hubert Vedrine to describe the U.S. as a superpower as it had no rivals

after the collapse of the Cold War.

both nations, one might be tempted to acknowledgeREMs title as the Grand Panjandrum.

Jim Coke holds a Bachelor and Masters degree fromCambridge University, is a Chartered Member of theChartered Institute for Securities and Investments inthe UK, a Member of the Hong Kong SecuritiesInstitute and an Associate Consultant at The HenleyGroup Ltd, Hong Kong.

Contact

Jim CokeThe Henley Group LtdSuite 2004-08, 20/fSt. Georges Building2 Ice House StreetCentral, Hong Kong

Tel: (852) 2824 1083Fax: (852) 2824 2024Emil:jnc@thehenleygroup.com.hkWebsite: www.thehenleygroup.com.hk

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