I grew up on a ranch in central California, and one of the lessons I learned early in life was taught to me by my uncle, who was fond of the saying, “When the horses are in your barn, you get to decide when they eat.”
I was reminded of this homespun lesson in property rights recently when I read that the European Union had requested the establishment of a dispute settlement panel at the World Trade Organization to try to resolve China’s export restrictions on rare earth minerals.
Rare-earth minerals, or simply rare earths, are used in products such as flat-screen TVs, hybrid cars and even Apple’s (NASDAQ:AAPL) popular iPhone. In fact, most electronic devices these days have some trace of rare earths in them.
As providence would have it, rare earths are found in abundance in China’s barn, and that gives the country a lot of leverage when it comes to the sector’s trade. And because of the increasing demand for rare earths, there has been an effort to increase their supply by loosening China’s grip on these vital minerals.
The latest appeal to the WTO by the European Union, the U.S. and Japan is the next step to the formal WTO consultations on the dispute held in April. The next step from here is WTO litigation to seek compliance by China with its international obligations.
Here’s the money quote from EU Trade Commissioner Karel De Gucht statement on the issue:
“China’s restrictions on rare earths and other products are violating its WTO commitments and continue to significantly distort global markets to the disadvantage of our companies.”
China’s well-timed retort to this global pressure came with its recent release of the country’s first-ever white paper by the Information Office of the State Council outlining China’s rare earth industry. The report highlights issues such as the uncertainty about the overall supply level of rare earths. According to the report, China has approximately 23% of the world’s supply of rare earths — much lower than the estimated 36% of global supply that most independent analysts estimate.
This downplaying of the overall supply of rare earths by China is thought by many to be a way for Chinese officials to justify their restrictive export policies. The more skeptically oriented among us, myself included, see this move as a way to help keep rare earth prices firmly under China’s thumb.
One consequence of China’s move was a decided spike higher in rare earth stocks, and that could be a harbinger of things to come for the sector. Leading rare earth stocks such as U.S.-based Molycorp (NYSE:MCP), Canada-based Rare Element Resources Ltd. (AMEX:REE) and Avalon Rare Metals (NYSE:AVL) and Australia-based Lynas Corp. (PINK:LYSCF) saw a price spike last week after the release of the aforementioned China white paper.
The spike was a welcome development for the sector, which has been crushed over the past several months. For example, Molycorp shares are down more than 40% in the past three months, while REE shares have fallen more than 25% as have Lynas shares. Avalon is the real dog in the space, having been hit with a decline of nearly 53% in three months.
The prevailing fears over China’s economic slowdown have put a lot of pressure on all stocks related to the sector; however, the news of the country’s rare earths, and the new attention by WTO over export restrictions, could put these stocks back in the spotlight — and that could mean more upside for investors willing to dig into the rare-earth dirt.
As of this writing, Jim Woods did not hold a position in any of the aforementioned securities.