More Important Than Europe: China and Rare Earths

In terms of dollars, China is set to overtake the United States as the world’s largest economy next year.

They’ve “taken” our jobs. They hold $2 trillion of our debt. And they’re being looked to to bailout Europe.

Say what you want about China’s brand of Communism, the scoreboard clearly shows who’s winning the capitalistic game.

The amazing thing is we’re able to witness this metamorphosis in real time.

China’s evolution from Third World to economic king isn’t happening in geologic time, but in front of our very eyes.

In 2000, we used 25% of the world’s energy and China used less than 10%. By 2007, we used 22% and China used 16%. In 2015, we’ll be tied at about 18%…

By 2020, we’ll have fallen to 17% — and they’ll be up over 20%.

The force of their ascendancy is mathematically undeniable, and it’s permeated every crevice of the global economy.

The Flip of a Switch

George W. Bush signed a bill into law in December 2007 that banned the future sale of the incandescent light bulb.

Australia signed a similar bill the same year.

The sale of traditional light bulbs in Europe has been restricted since 2009.

Surely the market knew how that would affect the lighting industry. It would be a boon to makers of more efficient light bulbs like light emitting diodes (LEDs).

And a boon it was…

Companies in the space took off like rockets, shooting upwards of 1,000% in the two years after the civilized world started talking about banning old light bulbs, even in the face of a global financial meltdown.

But then, something happened.

As with solar, the creation of a brand-new, high-demand market led to stiff competition. A market once dominated by GE (NYSE: GE), Siemens (NYSE: SI), and Philips (NYSE: PHG) was seeing entrants like Aixtron (NASDAQ: AIXG), Cree (NASDAQ: CREE), and Veeco (NASDAQ: VECO) suddenly steal market share.

And as with solar, LEDs became a commodity. Prices plummeted. So did the stocks.

Compared to their 1,000% days in 2009 and 2010, a chart of the same companies over the last six months is cringe-worthy.

We saw headlines like:

• LED Lighting Prices May Drop 90% As Competition Grows to Meet Demand

• Cree Added To UBS List of ‘Least Preferred’ Technology Stocks

• Siemens Plans for Osram IPO Tested by Weakening Growth Outlook

It seemed like the LED sector was doomed.

The entire developed world switching lighting technology wasn’t enough to save it. Too many entrants meant economies of scale being reached, falling selling prices, and — gasp! — falling margins.

LED stocks had fallen between 40% and 60% in six months.

If only there was some way to get them back on track? Some country with a billion inhabitants to which the market always responds? A country whose economy and energy consumption was about to displace America as top dog?

Then out of nowhere, like an oasis in the desert, China announced this week it will begin banning the sale of incandescents in five years.

Not right now, like the rest of the world is doing. Five years from now.

And look what that same group of stocks does:

LED stocks were up 20% to 40% on the news.

So the moral of the story is this: Whatever China is talking about doing five years from now is 20% to 40% more valuable than what’s actually happening in the rest of the world today.

Papadapawho?

Allow me to set the record straight. The debt crises that have dominated headlines all week are inconsequential.

How can you expect me to believe Greek or Italian insolvency is going to drag down the entire market? It’s nothing more than the latest hyperbolic fodder for an insatiable 24-hour news cycle.

If Mediterranean nations teetering on the brink are going to take down the entire economy, how can a light bulb announcement in China send an entire sector up 20% to 40%?

On Monday, Greek Prime Minister George Papandreou was the most important man in the world. By Wednesday, he was out — and Berlusconi was the new “it” man.

All the while, the most important investment story of the week has been completely buried: China is once again manipulating the rare earth market.

With a 95% stranglehold on the market for metals that are crucial for making everything from LEDs to UAVs, China has been making waves for over a year now by toying with supply.

Last year, it sent rare earth prices soaring when it cut export quotas by more than 37%. That was enough to send rare earth miners outside of China up thousands of percent.

This time, China’s largest rare earth producer, Mongolia Baotou Steel Rare Earth, has decided to halt production for an entire month in an attempt to drive up prices once again.

Because these metals are critical for defense applications, Congress is mulling the creation of a type of rare earth strategic reserve, similar to what we have with oil.

A report is currently being prepared by the Defense Logistics Agency and will be delivered to Congress by the end of the year.

If China can alter the movement of global markets in turmoil with a lighting announcement, wait until you see what continued rare earth price manipulation and the creation of a stockpile will do.

As Rare Element Resources (AMEX: REE) noted in the Financial Times last Friday:

… the creation of a stockpile could exacerbate the shortage of rare earths outside of China. It may therefore be prudent for the US government to delay its implementation until three or four years after the ramp up of production from the main non-Chinese pure-play rare earths miners, Colorado-based Molycorp (NYSE: MCP) and Australia’s Lynas (ASX:LYC).

No matter when we start our stockpile, one thing is clear: A rare earth supply crunch is on.

Any company with access to them outside of China (and its investors) is about to be rewarded handsomely — no matter what’s going on in Greece or Italy.

I have a few plays in mind, particularly one I recently flew to Alberta to check out personally.

You’ll be hearing more about them in the coming weeks.

Call it like you see it,

Nick Hodge
Editor, Energy and Capital