On December 27, 2011 the Chinese Ministry of Commerce announced the first round of allocations of rare-earth export quotas for 2012, to individual companies operating in China. The total export quotas allocated during this first round come to 24,904 t of rare earths. Before we get into more specifics with the numbers, it is important to note that this announcement was unusual for three reasons:

1. The Ministry issued separate quota allocations for light (LRE) and medium / heavy (M/HRE) rare earth products, and not just for rare earths as a whole. We’ve been anticipating this change for some time, based on industry chatter from within China, but 2012 marks the first time, to my knowledge, that these separate allocations have been rolled out;
2. Also for the first time (again, to my knowledge), the Ministry clearly telegraphed the intended TOTAL export quota for the entire year, prior to making the usual follow up allocation announcement next summer; and
3. The Ministry separated individual companies into two groups – the first group received confirmed quota allocations, while the second received only provisional allocations. Companies were placed into one of these groups based on their progress towards implementing new pollution control regulations, with the latter group only getting their allocated quotas if they meet the various requirements by July 2012. Companies who fail to meet the new requirements, will have their quotas re-allocated to other companies.

In the announcement from the Ministry, it was stated that the first round of quota allocations (totaling 24,904 t) will represent 80% of the quota allocations for 2012, which indicates that the total for the coming year will be 31,130 t of rare earths, slightly higher than last year. Here’s how the two groups of allocations break down:

Let’s now break this down further – first, here are the companies that received confirmed quota allocations, divided into sub-lists for Chinese and Chinese / non-Chinese joint-venture (JV) companies. The two sub-lists are sorted from highest-to-lowest total allocation:

* Part of China Minmetals Group, which was allocated a confirmed total of 2,457 t.

Next, are the companies that received quota allocations that are provisional on them meeting the new pollution-control standards, again divided into sub-lists for Chinese and Chinese / non-Chinese JV companies. The two sub-lists are sorted from highest-to-lowest total allocation:

** Part of Baogang Group, which was allocated a provisional total of 3,450 t.

Finally, here is a comparison of the quota allocations for the past three years (compare to the projected total of 31,130 t of quota for 2012):

It can be seen that a significant majority of the Chinese / non-Chinese JV companies were placed into the provisional category, including both of the rare-earth enterprises operated by Rhodia (Baotou Rhodia Rare Earth Company and Liyang Rhodia Rare Earth New Materials Company) and one of the enterprises operated by Neo Material Technologies (Zibo Jiahua Advanced Material Resources Company).

As usual, in addition to the numbers, the Ministry also published its algorithm for assigning specific quotas to individual companies, out of the total allowed. This year, it was based on both the total volume (50%) and the total value (50%) of exported rare-earth sales for each company, in the last three years, compared to the industry as a whole.

Also as usual, a significant section of the media (both mainstream and industry-specific) got this story all wrong, incorrectly focusing on the difference between total quotas allocated and announced at the end of 2010 for 2011 (14,508 t), and the confirmed quota allocations noted above (10,546 t). The valid comparison has to be between whole-year allocations. We probably need to stop thinking about these quota allocations as being specific to six months of a given year only. The Chinese Ministry of Commerce has specified the details for 80% of 2012′s quota, and has indicated the total value of the quotas as a whole. We can expect an announcement in the summer of 2012 giving the details of which companies were allocated the remaining 20% of quotas, and whether or not the companies allocated provisional quotas, received them, or if instead they were reallocated to other companies, and which those companies might be.

There are still some unknowns about the recent quota announcement, which will be important to clarify in the near term. We need to see if any additional rare-earth product types have been added to the list that are counted for quota purposes. I’m also keen to confirm that the term “light rare earth” in the context of this announcement, refer to products based on lanthanum, cerium, neodymium, praseodymium and samarium, with the term “medium / heavy rare earth” referring to the rest.

A comment on the allocation of confirmed vs. provisional quotas: unlike a number of industry conspiracy theorists out there, I do not believe that the exclusion of the Baogang Group of companies (and others) from the confirmed quota category, until they complete efforts to clean up their environmental act, is some sort of smoke screen or ruse. Neither do I believe that any aspect (with perhaps one exception) of the announcement, was some sort of response to the approaching on-streaming of Mount Weld in Australia and Mountain Pass in the USA. It seems clear to me, based on discussions with industry insiders, that China continues to march to the beat of its own drum, and while potential new sources of supply from outside of China are of course on the radar in China, they do not drive internal policy.

That said, I will say that it seems curious to me, given the collapse in actual rare-earth exports from China in 2011 compared to the quotas allocated, that the total quotas planned for 2012 are actually higher than for 2011. We know that the significant price increases for these materials were the key factor in the demand destruction (temporarily or otherwise) seen in 2011 (with lanthanum- and cerium-based products seeing the largest declines in demand). It is possible that the authorities in China see prices falling much further than the recent decreases that we’ve seen, to such low levels that the demand for exports will return to 2009 / 2010 levels, which would “fill out” the 2012 quota allocations.

The questions in my mind then, are these: is the higher-than-2011 total quota level for 2012 simply an action taken passively in the face of anticipated price decreases (partially due to anticipated competition from Mount Weld and Mountain Pass towards the end of 2012)? Or is it in fact an indication that the authorities intend to actually step in and to intervene – forcing prices lower than their current levels, in a bid to get exports back up to the 30-31,000 tpa level? The answer remains to be seen…

One final note: although it is highly unusual for the Chinese Ministry of Commerce to make the allocation of quotas provisional on meeting certain regulations, it is actually not unprecedented. Last year, 62 t of quota were provisionally allocated to one company, Pingyuan Sanxie Rare Earth Smelting Company, on the proviso that its recent (at the time) infrastructure improvements were inspected and approved by a local regulatory agency in March 2011. The provisional nature of this quota allocation is the reason why you might see slightly different total quotas allocation numbers for 2011 – mine, above, includes the 62 t – many others do not.

There is not a global “rare-earths market.” There are local, regional, markets for individual rare earths in separated. highly refined forms such as chemicals for manufacturing fluid cracking catalysts, and metals for producing alloys to manufacture rare-earth permanent magnets, or nickel-metal-hydride battery electrodes.

Even if your thinking is that the markets are totally globalized, you will still have to reconcile your belief with the fact that rare-earth prices within China are substantially lower than they are outside of China. China solves the arbitrage problem (buying low and selling high) by strictly limiting export volumes (otherwise they would all flow to the region of higher price, right?). In addition, China strictly limits the imports of rare earths in any form. I have personally been involved with attempts to import both ore and scrap rare-earth permanent magnets into China for processing. Both projects were initiated by Chinese companies looking for supplies for the Chinese market. Both projects were denied licenses by the Chinese government. This experience is why I question those who say that their markets will include mainland China. I do not believe that Chinese companies will be allowed to pay above Chinese market prices. for natural resources that can be produced in China.

A small number of the total number of rare earths, perhaps five of the 16 naturally occurring rare earths, are critical in their uses. There are no economic substitutes for them giving the same or similar performance. Everyone reading this article will I hope, have previously gone through my colleague Gareth’s definitive Critical Rare Earths Report, available from the TMR web site.

I predict that very few of the specialty-metal junior miners that could produce the particular heavy rare earths demanded by the current- and near-term market, will ever get into actual production, and of those, only the ones developing deposits containing commercially recoverable heavy rare earths will survive. Commercial in this sense means that they will be able to produce heavy rare earths at the lowest cost and at less than the total market demand.  Keep in mind that ore concentrates are nearly the least valuable forms of the rare-earth supply chain (the raw un-concentrated ore being the least valuable).

The ore concentrate must be “cracked,” i.e., its metal values must be separated chemically from the minerals, and immediately within the cracking process or just after it the nuisance metals, such as radioactive thorium and uranium, must be removed or left in the tailings (residue). The resulting pregnant leach solution (PLS) must then be separated into the individual rare earths and these must be in as pure a form as possible.

The purified individual rare-earth chemicals so produced. must then be reduced electrochemically or metallothermically to pure individual metals.

The metals will then be made into alloys, and the alloys into products such as rare earth permanent magnets, and nickel metal hydride battery electrodes.

Some of the purified chemical forms will be processed directly into, for example, fluid-cracking catalysts, without going through the metallic form at all.

The ONLY WAY rare earths become of value, industrially, is by passing through the above supply chain until they have been transformed into a finished useful form. The exact makeup of these useful forms is dictated by the end user. The supplier at every level of the supply chain must conform to, and target, the end users’ requirement. This is why the stockpile discussion is so premature. The real question is: “What is to be stockpiled?” That question can only be answered by a close study of  individual companies and industries and their specific demands.

The rare-earth part of the junior-mining sector has been for at least the last four years viewed in isolation by mining and financial analysts wearing blinkers.  A myopic vision of this small sector of the natural-resources market, which has vastly overemphasized its importance, has thus been developed and continues to be maintained.  A fantasy of growing and infinite demand and inelastic prices (prices not driven by simple supply and demand) increasing without limit, has placed the most emphasis on those rare-earth juniors who say that they will produce in the near term, from single mines, as much material as the Chinese are now producing from a combination of dozens of mines and refineries constructed and put into operation over a thirty-year period. As one analyst has put it “only the grade and total weight matter” in non-Chinese rare-earth production. Nothing could be farther from the truth.

The decades and thousands of man-years it has taken the Chinese to achieve their current capacities and capabilities are simply ignored by “investor analysts” who wouldn’t and don’t know the difference between neodymium and salami to start with and think that “the” solvent exchange is on Bay Street in Toronto near the Toronto Stock Exchange.

One of the positive results of the recent apparent correction (i.e. drop) in rare-earth stated prices is that this has exposed just how foolish the stock market has been in valuing a tiny metals market.  There was never any rational way that the prices for anything could simply increase by a factor 10 in just a few months and hold there and then go up again.  Rare earths have been treated as if they are vaccines when there is a plague among us. No price was considered too high for these “critical” substances. In fact they are critical mostly to lifestyle not life itself, and certainly not to the strength of the US, or any other, military, but rather to the efficiency of its defense technologies.

I asked myself when the current mania began, that if rare earths are so important, then why did the financiers and industrialists in the USA, in particular, actively push the Chinese into the position of being the sole source of them when ALL of the major discoveries of and advances in the use of the rare earths over the last 30 years have been made in the USA?

The answer to this question is economics. Economics is also the reason that the prices of the rare earths are rapidly correcting as Chinese intentions become clearer.

China has grown into a world-class economic power through the extraordinary creation of a huge sustained rate of growth of its GDP, based on the marshaling of its national resources of people, resources, and capital into the largest single-goal-directed economic entity in mankind’s history. The single goal of the Chinese Communist Party, the sole political entity in China, is to raise the standard of living of all Chinese people as much as possible, by any means possible, in the shortest period of time. In China, the political system to achieve this is known as “socialism with Chinese characteristics” and the chosen economic system to achieve this goal as “capitalism with Chinese characteristics.”

I think that the misunderstanding of “capitalism with Chinese characteristics” by the socialist-capitalists of the West is manifested most clearly in the idea that the goal of Chinese state economic planning is and must be individual “profit”, in exactly the same sense as is the goal of private capitalism outside of China.  Individual profit is allowed at the moment so that wealth can be created rapidly in the service of the goal of the state.

China has been very lucky to have had a foundational  leader to unify the country, albeit ruthlessly and brutally, who was followed in short order  by a brilliant economic leader such as few countries have ever had.  In a way this is exactly the opposite of the experience of the former Soviet Union, which embarked under Stalin on a dead-end course to state bankruptcy with a goal of nineteenth-century empire building, almost completely overthrowing the ideas of  the Soviet Union’s foundational leader. The Western democracies without even so much as an industrial plan, such as the USA, look economically precarious to the central economic planners of China, who themselves are dismissed as nothing more than the latest iteration of Soviet central planning. China is not following the Soviet model of the path to communism, but China learned from the Soviet failure, and it learned well.

China, since the reforms of Deng Xiaoping,  has created and nurtured until now an export-driven economy, which has allowed the Chinese to rapidly accumulate large amounts of reserve currencies (principally US dollars and Euros) representing the surplus of the payments they have received from their largest trading partners. China’s currency has not been allowed to become “convertible” in the free market. Its value vis a vis the reserve currencies, is set only by the Chinese government and not by the market. The Chinese store of assets anchored by its hard-currency reserves is the most powerful weapon in the history of economic nationalism.

It now seems that the Chinese have become aware that the growth of their manufacturing economy is slowing, so that if a high “floor” rate of growth is to be maintained, then it is the time for some structural adjustments.  China has stated as official policy that it now wants to transform itself into a mixed economy, led ultimately by domestic consumption. This means that the types and amounts of resources now allocated to export, will have to be reviewed to see what amounts of them will have to be redirected to support the growth of the domestic consumer economy.

To bring its particular sub-sector of the domestic natural-resource market into conformity with the new program direction, rare-earth mining has had first of all a cap placed on output and then, just now, an output licensing system put in place so that supply could be accurately measures and prices accurately “discovered.” In this way,  the legal market could become the total market, with taxes calculated and collected on all production, as well as facilitating accurate measurement of supply for state-planning purposes. Just this week it was been announced that of 80 applications for rar-earth production operating licenses received since the reforms began earlier this decade, the Chinese government has selected just 15 that conform to the NEW environmental standards. Production from unlicensed sources will now be a serious felony and the total of the amounts purchased either for use internally or for export will be checked to make sure it matches LICENSED output.

This has resulted in a price correction that has been described as the deflation of a bubble. In fact the prices were earlier driven up by Chinese speculators and illegal miners trying to offload inventory, before it became worthless or dangerous, because it wouldn’t have a necessary license to enable it to be sold in the legal market. The new regulation scheme will stabilize prices, since supply will be able to for the first time to be matched to demand.

We will also now see a clear differentiation in supply and demand between the light rare-earth elements (LREEs), and the heavy rare-earth elements (HREEs). HREE production is, at best, flat in China, currently the sole producer, even as demand proceeds to grow. This can only result in firm current pricing and a steady increase in prices over the years to come for the HREEs.  Since non-Chinee HREE production will, at best, grow slowly, if even at all, it is likely that HREE supply will not meet demand anytime in this decade.

This is a far cry from the situation in the LREEs where China is operating at less than one-half of mining capacity ,and possibly at even a lower level of utilization in refining capacity, and there is at the same time a strong possibility that Lynas (ASX:LYC, OTCQX:LYSDY) or Molycorp (NYSE:MCP) or both will come into large-scale production by 2014. This situation will simply maintain the probability of oversupply of the LREEs in the near to mid term. This should stabilize and hold down the prices of the LREEs, as speculation is discouraged internally by new Chinese moves.

Finally it is obvious that the overwhelming market for the rare earths as raw materials is Southeast Asia, primarily China (60%) and Japan (30%), totaling 90% of the world market. It is incredibly naïve to maintain that as large a production as is predicted for even just Molycorp, could be absorbed by the US market unless you assume the total collapse of the Chinese and Japanese export markets for REEs. The only way that Molycorp could sell its total planned production would be by marketing into China and Japan. This will place Molycorp, at least in China, in direct competition with a mature Chinese mining sector, with much lower costs across the board than have ever been previously achieved, in practice, outside of China. Lynas faces the same marketing problem, but its mix of REEs is perhaps better suited to the world market place. In order to sell anything into China, any supplier must conform to strict Chinese import rules, regarding radiation and other contamination levels. This makes a non-Chinese rare-earth supply chain even more important to potential large-scale and therefore lowest-cost producers, but it is not the mining costs that are determinative – it is the lowest overall cost to the sale point of your rare-earth product that is important.

First to pass the post is also going to be a very important benchmark for the success of a large LREE venture. If Lynas should succeed in getting the go-ahead from the Malaysian government soon, then it will rapidly thereafter begin producing large quantities of LREEs and some HREEs also from its Australian ores. This fact is a key reason why Molycorp is attempting to accelerate its target date for actual production, from newly mined material. Both Lynas and Molycorp have large fixed costs of operation. Any inability to sell all that they can produce may be fatal to their survival in the face of a market that is not as large as it is held out to be. In fact they are of course competitors with each other. If either is to survive, this will be if and only if, the Chinese do not choose to again ramp up LREE production, targeted for the export market.

Governments may well buy small quantities of critical metals for security purposes, but the government of Australia needs hardly any such material and the actual needs of the US military are small.  If there is a revival of the total REE supply chain in the USA then a stockpile to protect the INDUSTRIAL supply chain could be enough reason for private industry to fund a Molycorp or a Lynas.

The key stockpilers of the REEs as rare materials over the next decade are likely to be the nations and industries with the most pressing needs for them. Those would include China, Japan, Korea, India, the EU, and last, and presently least important, the USA.

Stockpiling may be used as a reason to capitalize security of supply. In other words stockpilers will pay more to ensure domestic supply.

With regard to HREEs, based on the information that I have about the deposits, management, markets and politics to be served by the potential rare-earth mines that can produce HREEs, I have reduced my interest in the space to the following. I may have missed a good one or included a bad one, but I think that the survivors in 2015 must be in my list today:

• Avalon Rare Metals (TSX:AVL, AMEX:AVL)
• Great Western Minerals Group (TSX.V:GWG, OTCBB:GWMGF)
• Matamec Explorations (TSX.V:MAT, PK:MTCEF)
• Quest Rare Minerals (TSX.V:QRM, AMEX:QRM)
• Rare Element Resources (TSX.V:RES, AMEX:REE)
• Tasman Metals (TSX.V:TSM, PK:TASXF, F:T61)
• Ucore Rare Metals (TSX.V:UCU, OTCQX:UURAF)

I believe that REEs can be produced as secondary values / byproducts at the lowest costs, by:

• AMR Minerals
• Alkane Resources (ASX:ALK, OTCQX:ANLKY)
• Orbite Aluminae (TSX.ORT.A)
• Rare Earth Metals (TSX.V:RA)

Low-thorium deposits are highly desirable for LREEs and, of course, HREEs but they are few and far between. Owners of such deposits include:

• Rare Earth Metals (TSX.V:RA)
• Tasman Metals

Recycling from industrial process and end-of-life scrap plus REE slags and residues, can provide a limited but significant and immediate supply of products at the lowest cost. This is because the energy and cost of mining and separating them from each other in gross is built into the scrap as intrinsic value.

In 1976, China exported for the entire year the dollar value of its current (2011) daily exports! But, what exactly does China export? Two things: Labor content and the least quality to make a product competitive. What exactly does China import? Two things: Intellectual property (often as in the case of the American OEM automotive industry at NO COST) and raw materials.

Let’s focus on raw materials.

The best investment possible is to supply a growing demand for a material that is scarce to begin with. The LREEs are not rare nor even hard to get at; they are just currently too expensive to produce against the Chinese supply chain. On the other hand, the HREEs are scarce even in China, and also even in China their production costs are high due to the low grades that are worked.

Thus, it turns out that deposits containing the highest ratios of HREEs to total REEs, where they can be worked so as to produce a product that is saleable competitively with the Chinese production costs, can be sold into China itself as well as into Japan.

In the case of the HREEs, it is even possible to try to undercut Chinese prices to gain market share. If the production is price competitive, or even a little higher than that of China, then capitalizing the security of supply or national security issues can level the price differential at least for a critical quantity.

The idea that it is the highest-grade, largest-volume deposit that is most likely to have commercial success is I believe, confused and naïve in the extreme; it equates market capitalization & share-price maintenance, promotion and manipulation with the probability of actual commercial, competitive, production in the real world markets.

Disclosure: Jack Lifton is long on Great Western Minerals Group (TSX.V:GWG). He is a non-executive director of AMR Minerals. He does ongoing paid consulting for Ucore Rare Metals Inc. (TSX.V:UCU), Rare Earth Metals Inc. (TSX.V:RA), Rare Element Resources Ltd. (TSX:RES) and for Tasman Metals Ltd. (TSX.V:TSM).

The Chinese Ministry of Commerce today announced the allocation of rare-earth export quotas to individual companies operating in China, for the second half of 2011. The total allocation for H2-2011 is 15,738 t of rare-earth materials to 31 different companies in China (with seven of these companies contained within two different business groups). This gives us a total of 30,246 t of quota allocated for 2011 – almost the same amount as allocated in 2010.

A comparison of the quota allocations for the past three years is shown in the table below:

The individual allocations of quotas are listed in the table below, divided into lists for Chinese- and foreign-owned companies. The two lists are sorted from highest-to-lowest allocation.

It can be seen that once again, the rare-earth enterprises operated by Rhodia (Baotou Rhodia Rare Earth Company and Liyang Rhodia Rare Earth New Materials Company) and Neo Material Technologies (Zibo Jiahua Advanced Material Resources Company and Jiangyin Jiahua Advanced Material Resources Company) received between them the majority of quota allocations for foreign-owned companies, operating in China.

* Part of Baotou Steel Group Corporation, which was allocated a total of 3,220 t.
** Part of China Minmetals Corporation, which was allocated a total of 1,327 t.

It is likely that the individual quota allocations were made according to a formula similar to that previously used, What is unclear at this point is whether or not new types of materials have been added to the list of rare-earth-containing compounds, for the purposes of being counted towards the quotas, when exported. Some ferroalloys are now on the list, but I don’t think that their presence is the big deal that some commentators are making them out to be.

The allocated quota numbers for H1-2011 were almost certainly NOT all used up, by June 30, 2011. In fact, all indications are, from the export statistics (murky as they are), that there was a significant shortfall. Granted, the likely root cause of the shortfall is the very high price for many of these materials at present.

The greatest speculation surrounds the potential inclusion of neodymium-iron-born (Nd-Fe-B) alloys, used for permanent magnets. At present there is no evidence to suggest that the list of materials to which the quota allocations apply, included Nd-Fe-B; almost all of the companies listed above are the same as in previous years, and are associated with simple compound production, not Nd-Fe-B alloy production.

However, we’ll continue to look into this and we’ll let you know if we find out any more detail on the list of materials covered.

If you’ve read beyond the title above then you are the audience that I am seeking. The Wall Street Journal (WSJ) published an article this morning with the title “China To Set Up Strategic Reserve For Heavy Rare Earths – Sources“. The WSJ said that:

China plans to set up a strategic reserve for heavy rare earths in what would be another step towards protecting key resources and ensuring supplies for the domestic market, people with direct knowledge of the plan said. The plan, which hasn’t yet received final government approval, would likely reduce volumes for export and boost rare earth prices.

The WSJ goes on to say that

It also would follow an approval in 2009 to build strategic reserves of light rare earths in China’s Inner Mongolian Autonomous Region. That plan is supposed to be undertaken by Inner Mongolia Baotou Steel Rare-Earth (Group) Hi-Tech Co. (600111.SH), the country’s largest rare-earth producer by output.

You can read the rest of the article here, and I suggest you do so before going any further.

As I have been reporting for the last two years, China is going full steam ahead with a critical-materials stockpiling program to protect Chinese domestic manufacturers, from any potential interruption of critical supplies.

Two years ago, it was reported that Baotou Rare Earth (BT) had received permission to stockpile up to 300,000 tonnes of rare earths. BT is the world’s largest producer of light rare earths; last year it produced at least 50,000 tonnes of lanthanum, cerium, neodymium, and praseodymium.

Last year it was announced that the Chinese government had decided to consolidate the rare-earths industry, geographically, under a small number of very large (world-class) Chinese metal producers and metals-trading companies.

Late last year it was announced that for environmental reasons, rare-earth production would be reduced and no new (increased) production or even exploration licenses for mining would be issued, until 2012.

So until this morning we had a total reorganization of, at least, the global (i.e., Chinese) light-rare-earth-supply industry well underway, although only just now being implemented. Today, the equation expands to encompass the heavy rare earths, which are mostly produced outside of the geographic region the rare earth production of which has been totally subsumed under BT ‘s authority and responsibility.

Thus it will now fall mostly to Jiangxi Copper to supervise the creation of a stockpile of heavy rare earths (HREEs) in the geographic region in which it has been given the mandate over the production of rare earths.

China is now committed to:

• The rationalization (thus restructuring) of the Chinese rare-earth mining industry (its reorganization into efficient profitable units, all operating legally with state-mandated production quotas);

• The environmental remediation (cleanup) of the industry, which operates today with a large uncontrolled segment of “cowboys’ who don’t obey any health, safety, or TAX rules, and

• The creation of stockpiles of all of the rare earths at levels of what would now be several years of demand!

Since China is today essentially the only producer of heavy rare earths, as well as the producer of 98% of the light rare earths, and since stockpiles can be viewed as purchased inventory, then this means that the virtual demand for all of the rare earths in China will skyrocket.

China clearly fears that the necessary cleanup of the rare-earth-production industry will be disruptive, if not planned for and executed on a totally controlled grand scale. It has therefore decided to do so and has begun to do so.

This is a national industrial policy in action. America has no such policy and, even if it wanted to have such a policy, there is no possible mechanism to enable it, short of a war footing for the entire economy.

This is a command economy in operation. By contrast, America has a “free market” economy.

Unless the rest of the world now shifts its focus to the production of heavy rare earths and their stockpiling, then by 2015 at the latest, there will be virtually no HREEs available outside of Chinese control, and thus, any manufactured product requiring a HREE will by necessity have to be made within China by a manufacturer who is either Chinese or has access to quota ultimately issued by the Chinese authorities.

TMR believes that a number of the HREEs, including dysprosium and terbium, are already very much in short supply, even without the new demand from a stockpile-building regime in China. My colleague Gareth is scheduled to publish, later this month, a comprehensive report that digs into the details of the deficits, and how long they are likely to last.

If all of this occurs, then the only substantial rare-earth-product industry creating demand outside of China that can survive, will be the fluid-cracking-catalyst industry and this will be only if there are LREEs produced outside of China.

To summarize and to emend:

• Chinese actions already underway will create a window of opportunity, for both LREE and HREE producers in the rest of the world.

• The added virtual demand to build the massive Chinese stockpiles of rare earths will keep REE prices high and going higher for years.

• The shortage of separation and refining facilities for HREEs outside of China is now the roadblock for HREE production outside of China.

• China, by its actions, is creating enormous pressure on Western manufacturers, including those in Japan and Korea, to move the high-tech operations they have been safeguarding as domestic priorities, to China, in order to obtain critical raw materials.

• In my opinion, China is building a stockpile of this magnitude, in order to insure against the possibility of a domestic supply interruption of rare earths, and has no interest in safeguarding the manufacturing world outside of China.

• At the same time, the stockpile will drive more manufacturing to China, thus increasing Chinese wealth creation and employment.

The only way that the industrial-policy-free and resource-underdeveloped West can maintain its industrial plant that requires rare earths, is to develop the entire rare-earth supply chain outside of China.This means that going forward from now, the best investments in rare earths outside of China are:

• Deposits that can produce HREEs as asoon as possible;
• Rare-earth separation facilities;
• Rare-earth conservation research;
• Recycling

Here endeth the lesson.

In the latter part of March 2011, the Chinese Ministry of Land and Resources published details of the 2011 rare-earth production quotas. It was widely reported that the quota consisted of 93,800 t of rare-earth oxides (REOs), made up of 80,400 t of light REOs (LREOs) and 13,400 t of heavy REOs (HREOs).

The Ministry also published further detail of the quota allocations by province / region, as they have done for prior two years. Here is the breakdown:

Source: Chinese Ministry of Land and Resources

What’s interesting here is that while Inner Mongolia is still the designated primary source for LREOs, Sichuan and the other production areas make up over 35% of the total for proposed LREO production, slightly up from previous years.

Note also that these are the official production numbers, not taking into account the significant uncontrolled / illegal production that takes place.

Chinese domestic demand growth for the rare-earth-permanent-magnet (REPM) metals neodymium (Nd) and dysprosium (Dy) over the next five years, will be strongly influenced and perhaps determined by, the emphasis on industrial policy announced in the new Chinese economic development Five-Year Plan. The general outline of this 12th Plan is reviewed and analyzed in the London Telegraph for March 5, 2011, in an article which is entitled “China’s five-year plan: key points“.

Before we discuss the specific section of the new Five-Year Plan that influences rare-earth-metals demand growth, we first need to understand that China’s industrial economy is centrally planned and rigorously controlled in detail, by the China State Council. This is the executive body of the Chinese Communist Party, which operates in a “King-in-Council” manner similar to the way in which the British government operated when its monarch had actual power centuries ago. In the case of the China State Council, of course, it is the “President” of China who is the head of state while the Prime Minister and State Council members are the daily overseers and rulers of the operations of the government.

It’s not appropriate to refer to the China State Council as equivalent to the Chinese President’s cabinet as many pundits do. The State Council is much more than an advisory group to the President; it is actually operating as the office of the executive branch of the government, and it consists of powerful men, all members of the Communist Party hierarchy, the men who actually rule China. The China State Council does not recommend industrial policy; it defines, organizes, and controls the Chinese economy in order to achieve the goals of the Chinese industrial policy.

The Council sets the goals ahead of time for each five-year period, and it has traditionally done so by asking the permanent civil-service bureaucracy to prepare position papers on their needs and wants, prior to the finalizing of each new Plan. From these studies the China State Council decides on what the goals of the Plan will be, and how the state’s total resources will be allocated to implement it successfully.

The current Plan just officially promulgated is the 12th since the 1949 revolution, which brought the Chinese Communist Party into power. This centralized planning of goals for industry is a legacy of the Soviet Union’s evolution of the economic measures thought to be necessary for the transformation of socialism ultimately into communism. Needless to say, Lenin and Stalin would no longer recognize the policies of the present Chinese Communist Party, as having originated in their own theorizing and economic experimentation, which was finally an unmitigated disaster and eventually brought about the economic and political collapse of the Soviet Union.

Second, you need to understand that the job security of a Chinese manager is a direct function of his or her ability to meet the goals of the Five-Year Plan. Only systemic failure can save a manager who does not meet his assigned goals from disgrace and unemployment. Therefore Chinese managers take their assigned goals very seriously. Plans are made in detail by industry in China, in collaboration with the central and provincial governments,  to allocate the resources of labor, capital, and natural resources necessary and sufficient in the eyes of the planners to meet the industrial goals for production.

Beijing may alter the timing of the execution of any particular aspect of the Five-Year Plan, but local officials have no such power to do so.

Note well that this is the complete opposite of American practice, where legislators, if they bother with this type of planning at all, set over-reaching goals and then leave it to private industry and capital to meet them. Typically when Western politicians simply do not understand a technology, such as vehicle electrification and the production of cost-efficient batteries for such technologies, they then simply set goals to be met after they leave office. They then accept the congratulations of their similarly inclined constituents who like them know nothing of economics, manufacturing engineering, or from where natural resources come and at what rate.

This is not the case in China, where bureaucrats are chosen for specific expertise as well as political reliability.

The punditry usually refers to the Chinese planning as industrial policy, but it is as much direction as it is just simple policy.

The Telegraph article contains the following in its translation of the Five-Year Plan’s key points:

“Introduce targets for energy efficiency and consumption that will see China finding 20pc of its energy from non-fossil fuel sources by 2015. The contribution of coal and oil to fall from its current 90pc to 80pc.”

When I was in Beijing in August 2010, for the 6th Annual Chinese Society of Rare Earths Summit, a speaker representing the Chinese wind-turbine electricity-generation industry told the conference that in the next two Five-Year Plans (the 12th and 13th) beginning in 2011 China, in order to reduce the usage of coal to generate electricity and to improve energy-use efficiency per productive unit of capacity, would add 330 gigawatts of wind-generated electrical power, and that this would require a total of 59,000 metric tons of neodymium.

He said that the wind turbines to be built would use REPM-type generators to save on weight and maintenance. The reaction of the crowd, overwhelmingly made up of Chinese rare-earth miners and refiners, seemed to be one mostly of surprise.

I understood why this was so. The Nd required makes up just 28% of the total typical neodymium-iron-boron (Nd-Fe-B) alloy that comprises a REPM. Yet the spokesman from the Chinese wind-turbine industry had clearly said, and his slide showed, a need for 59,000 tonnes of new, additional, Nd demand that had not before been added to the demand-growth figures anyone had seen.

The Chinese businessman next to me had been busy photographing the wind-industry spokesman’s slides. I asked why he didn’t just request a copy of the presentation. His reply was “You’ll never get a copy from these guys. They’re running trial balloons for the State Council.”

Nd is typically around 20% of the total REEs produced by the Chinese light-rare-earth industry. That total last year, 2010, has been said by Dr Chen of the China Society for Rare Earths to have been just 89,000 tonnes of which 77,000 tonnes, or 86%, were light rare earths. This means that the Chinese production of Nd for 2010 was about 15,000 tonnes.

Of the 12,000 tonnes of heavy rare earths produced in China in 2010, just 7% was reported to be the heavy rare earth Dy, which would mean that 840 tonnes of Dy were produced from the so-called ionic absorption clays in southern China.

A typical Nd-Fe-B-based REPM contains 3-12% of Dy overall – this means that 100 kg of such magnet alloy contains from 3 to 12 kg of Dy as well as around 28 kg of Nd. The OEM automotive industry uses the most Dy loading, as high as 12%, to give their REPM-based motors, sensors, generators and the like, the maximum service life at constant high-temperature use.

Even assuming that the new demand for Nd-Fe-B-based alloy for the Chinese wind-turbine industry uses only 3% of Dy, and even if the 59,000 tonnes of Nd were only 59,000 tonnes in total of magnets, one would still need an additional 1,800 tonnes of Dy just for this project, as well as an additional 18,000 tonnes of Nd! If the demand for new additional Nd for the wind-turbine project is indeed 59,000 tonnes then a minimum demand for Dy could be 6,000 tonnes, which would be, at current production, the total dysprosium produced for the next 7 1/2 years!

These demand-growth figures, assuming that the need is 59,000 tonnes of Nd, would require at least a doubling of current Chinese light-rare-earth-metal production and the total dedication of Dy production to this clean-tech goal for most of the next decade. If there is a further demand growth from the automobile industry, the current largest user of Dy-enhanced Nd-Fe-B-type REPMs, and that growth parallels the increase in motor-vehicle production expected in the next decade then this use alone will add the need for an additional production equal to the entire 2010 production of Nd and Dy.

We would then be looking at a minimum at a torrid 15% a year growth in the demand for Nd and Dy between 2011 and 2020, just from the Chinese domestic-wind-turbine industry, and the global OEM automotive industry.

Such growth may be possible for Nd production; it is unlikely to be achieved for Dy unless there is for the first time development of Dy resources outside of China.

The Chinese have emphasized over the last year that they believe their Dy resources are being exhausted, and that at current rates of production they have only 5-25 years of production remaining.

If the growth of demand for Nd and Dy above are correct, then it is most likely that Dy will be OR IS ALREADY in short supply.

Therefore unless rare-earth mining ventures with commercially significant Dy are now brought into production as soon as possible, then clean-tech growth outside of China will slow down or stop, depending on whether or not the clean-tech manufacturer has a Chinese source for Nd-Fe-B-based-magnet-containing components, and that Chinese source has an export license for rare-earth-containing components.

The buzz in the rare-earths industry over the past few weeks, sending the analysts scrambling to update their spreadsheets, has been the shocking news that China will become a net importer of rare earths by 2015, completely altering the supply and demand dynamics of the global rare-earth industry.

At least, that is, if this news is accurate… is it?

At the Critical Metals Investment Summit in Vancouver last month, a presentation was made on behalf of Dr. Zhanheng Chen, Director of the Academic Department of the Chinese Society of Rare Earths (CSRE), titled “China’s Role in a Changing Global Rare Earths Market“. Dr. Chen was unfortunately not able to be there, and it is my understanding that Mr. Jay Roberge of Tehama Ventures gave the talk instead.

In the presentation, Dr. Chen forecast a total supply in 2013 of 87,000 t from China, out of a total 134,000 t of global supply. He then forecast a total global supply target after 2015, of 278,000 t of rare earths, with the target for China’s production set at 100,000 t of rare earths. For China, this is not far off the current production levels, but is less than most analysts had been projecting for that time period. More important, this leaves a 178,000 t production target for the rest of the world (ROW), based on CSRE estimates, which is significantly higher than the total output of projects due to come on-stream in the next four years.

Later in the presentation, Dr. Chen indicates that there are “early signs that China is moving from [the] sell side to [the] buy side”, noting that 10,381 to of rare-earth concentrates were imported by China, presumably last year. Nowhere in the presentation does Dr. Chen use the term “net importer” to describe China’s situation in 2015, as has been widely reported on the rare-earth-industry grapevine and beyond.

To find out exactly what Dr. Chen meant, I dropped him a line to ask if he could clarify this notion that China will become a net importer by 2015. In his reply, he said that, “[it] is still too early to make an assertion than China will become a net importer by 2015“. He acknowledged that “[t]here is evidence that several China[-based] companies imported rare earth concentrate from CIS [Commonwealth of Independent States i.e. the former Soviet Union] last year”, as referenced in his Vancouver presentation. Dr. Chen went on to refer to heavy rare-earth elements, and indicated that “China might become a net importer soon” of these materials.

So, is the buzz with which I opened this article, accurate? I would say that it was not. At the very least, Dr. Chen made it clear that it is not he who is making the assertion that has been ascribed to him (while acknowledging the possibility of this happening for a small subset of the total REEs sold). For me the real takeaway from Dr. Chen’s presentation are the CSRE projections for ROW supply requirements beyond 2015.

Finally, for the record, I’m not accusing Mr. Roberge of mis-stating Dr. Chen’s position, or of putting words in his mouth :-) Clearly though, at least some folks in the audience got the wrong end of the stick last month, perhaps reading into the presentation, a sub-text that wasn’t there.

Food for thought.

Today’s Wall Street Journal has an article titled “External Surpluses Root Cause of China’s Inflation Problem.” It is a report of a talk given yesterday by Mr. Yi Gang, vice-governor of the People’s Bank of China.

The talk included the following comments:

“In addition to boosting the flexibility of the yuan exchange rate, China also should adjust resource prices to address imbalances,” he said, “as many resources are still traded in China at below their natural prices. China also should boost wages and social benefits to lift consumption, step up its enforcement of environment regulations and undertake other structural reforms to address imbalances.”

(emphasis added by me).

Repeat after me: The selling prices of the rare earths and other commodities within China are still too low. Thus, if the Chinese government did not strictly control their export, then the market would drive all of the supply out of China chasing the higher prices in the foreign marketplace. One current driver for such a foreign accumulation would be the stocking of strategic materials (stockpiling) by governments, to protect their domestic industry’s security of supply. Another driver could well be inventory building, by “once-burned, twice-shy” private corporations, finally reversing the 50-year reign of the just-in-time / no-inventory philosophy , which was a principal driver in the creation of this problem.

Chinese central-planning economists however also see this danger to Chinese industrial security of supply, and by extension as potentially then leading to high unemployment in the very important domestic Chinese alternate energy, green and clean-tech sectors.

The Chinese central bank, the Peoples’ Bank of China (PBOC) does not want to buy commodities as an alternative to US Treasury bonds, because this could disrupt the commodities market causing price volatility in the very asset they are trying to use to stabilize prices and the currency. Even more important, no commodity accumulation of sufficient size to soak up excess Chinese liquidity, would likely make a dent in reserves as large as those of China in any case, but it would certainly interrupt the flow of raw materials for industry.

The PBOC is determined to force China to grow its consumer sector without causing inflation, one of two of the PBOC’s greatest fears. The other is a massively corrected and thus much more-expensive yuan. Yet, by continuing to buy up surplus and hot money inflow dollars at a fixed rate, it feeds, and it knows it is feeding, inflation, and increasing the pressure on it to revalue the yuan or let it float.

The prices of the rare earths in China will have to increase soon or smuggling will become uncontrollable. That is human nature. In the long run the production of the rare-earth metals outside of China will help the Chinese by increasing the global supply and reducing global prices and thus eliminating the need for export controls. This is doubly true when one considers that China itself is the world’s biggest market for rare-earth metals, and its neighbor Japan, accounts for most of the rest of the global demand.

The rare-earth-mining economy within China is tiny as a proportion of the GDP, but the number of jobs dependent critically on the properties of the rare-earth metals required to manufacture green and clean tech, as well as communication and entertainment technologies, is not trivial. China’s central planning dilemma is that it must keep rare earths cheap, in order not to drive rare-earth-based component jobs off-shore, to lower cost countries such as Vietnam or India. Its own entrepreneurs are already doing this, by the way.

The result for junior miners with rare-earth claims, is that the race is on to produce more of what China needs to be produced outside of China, to relieve the pressure on its two-tier pricing economy for commodities such as the rare earths.

The Chinese government maintains strict overall control of China’s economy from Beijing. Chinese businessmen, however, have the same mindset as any other businessmen: maximize profit and reduce costs. In today’s China, the government wins and it may use a meat ax rather than a scalpel to enforce its decisions such as with the rare earths recently.

To think though that Chinese economists and central bankers do not see the problem is foolish.

I believe that the selling prices outside of China of the rare earths will continue to rise, until there is significant non-Chinese production of the rare earths. Then if supply exceeds demand, which I think likely, there will be a massive culling of those companies not in production, or of those that are too large, or too skewed to light rare earths. The prices of the heavy rare earths, so long as China continues to maintain that its supplies are being exhausted, must continue to climb. One respected analyst is calling for a dysprosium price of nearly $2,000/kg by 2020. If China does not find domestic new supplies of dysprosium I think the analyst is on the right track.

Be cautious when investing in the rare-earth sector. Very large forces are intersecting in it, and will make it very volatile in the near term.

by Geoff Hiscock – The Australian – Published: January 19, 2011

As Chinese President Hu Jintao wraps up his US tour on Friday with business meetings in Chicago, his country’s future role in the global rare-earth trade will be under scrutiny at a Critical Materials investment conference on the other side of the North American continent.

But instead of the usual discussion about Chinese domination of the rare-earth supply chain – it currently has more than 95 per cent of the market – two of Hu’s rare-earth specialists are due to speak at the conference in Vancouver, Canada on the theme “China to join the buy side.”

They are Lin Donglu, secretary general of the Chinese Society of Rare Earths and Dr Chen Zhanheng, director of the society’s academic department.

Chen has spoken previously on how China’s rare-earth industry is beset with environmental problems, and that no new mines could be allowed in China. He has also said it is in the industry’s best interest for a diverse and stable supply chain to be established.

Rare earths, along with other materials such as indium and lithium, are used in clean energy technologies and a host of devices that include permanent magnets, hybrid and electric car batteries, computer hard drives, smart phones, iPods, LED televisions, energy-efficient lights, lasers, petroleum cracking catalysts and sophisticated military items such as night vision goggles and missile guidance systems.

Rare-earth miners such as Lynas in Australia, Molycorp in the U.S. and IREL in India are moving to bring new plants into production as quickly as possible after China cut its 2011 export quotas of the strategic material and the U.S. Department of Energy warned of critical shortages over the next five years.

World demand for rare earths in 2010 was about 127,000 tonnes, a figure expected to reach 188,000 tonnes by 2015 as clean technology usage increases.

China’s Ministry of Commerce announced on December 28 its rare-earth export quotas for the first six months of 2011 would be 14,446 tonnes, a drop of 11.4 percent on the same period a year earlier. Nominal export quotas in 2010 were already down 40 percent on the 2009 figure.

According to the U.S. Department of Energy’s Critical Materials Strategy report released on December 15, five of the 17 rare earths — dysprosium, neodymium, terbium, europium and yttrium, as well as the processed rare metal, indium – are the “most critical” in terms of supply over the next five years.

The big demand drivers are permanent magnets for wind turbines and battery alloys for electric motors; these two applications alone are expected to account for more than 55 per cent of demand by 2014.

Although China dominates global supply from its vast and heavily polluted Bayan Obo mining region in Inner Mongolia, scores of mining companies around the world are racing to bring new plants on stream. Even so, it will take years for more than a handful of them to begin production, given the environmental constraints they face.

According to mining industry analyst Gareth Hatch of U.S.-based Technology Metals Research (TMR), 17 of about 275 rare-earth projects are at what he calls the advanced stage: four each in Australia and Canada, two each in the U.S., Greenland and South Africa, and one each in Sweden, Kyrgyzstan and Malawi.

Two of those – Mount Weld in Western Australia and Mountain Pass in California – are due to start production this year. Three others – Nechalacho in Canada’s North West Territories, Nolans Bore in Australia’s Northern Territory, and Bear Lodge in Wyoming, U.S., could come on stream between 2013-15.

Another possible source is India, where Toyota Tsusho, a Japanese trading house that is part of the Toyota automotive group company, said last month it planned to build a rare-earth processing plant in Orissa state this year. It aimed to begin shipping up to 4,000 tonnes a year of rare earths to Japan from 2012.

Toyota Tsusho’s project partner is Indian Rare Earth Ltd (IREL), a unit of the state-owned Nuclear Power Corp of India. IREL now extracts uranium and thorium from monazite minerals in alluvial ore deposits along the east coast of India. Rare-earth chloride mixtures are produced as a by-product of this extraction process, and these mixtures will be the raw materials for making rare-earth oxides.

According to Nicholas Curtis, executive chairman of Lynas, the Australian listed mining company which owns Mount Weld, China’s decision to limit exports in 2011 is an opportunity for companies such as Lynas to meet the supply deficit outside China.

He said Mount Weld was the world’s richest known deposit of rare earths. The company planned to concentrate ore at a plant on-site, before shipping it to an advanced processing plant it is building at Kuantan in the Malaysian state of Pahang. The first ore is due to be concentrated in early 2011, with the first feed of concentrate to the Malaysian plant in the third quarter of this year.

In November, Lynas struck a strategic alliance with Japanese trading house Sojitz Corp., to be its exclusive distributor into Japan. Japanese companies process about half the world’s rare earths before exporting the finished products to markets such as Europe and the U.S.

New York-listed Molycorp, which stopped production at its Mountain Pass plant in 2002 in the face of Chinese competition and environmental constraints, is spending US$531 million on a plant upgrade and is due to begin mining fresh ore this year.

In December Molycorp announced separate deals with Japan’s Hitachi Metals and Sumitomo Corp covering the funding, supply and manufacture of rare-earth end products, including alloys and magnets in the U.S.

China’s recent actions in the rare-earths market have prompted a storm of criticism about its control of the supply. That provoked a counter-attack last week from a senior Chinese commentator, Chen Weihua, who lashed out at what he called “the sheer hypocrisy” of the West.  Chen, deputy editor of the China Daily’s U.S. edition, wrote that the state of China’s rare-earth industry typified the serious environmental and social costs that China incurred in its role as the world’s “manufacturing workshop.”

“When China takes action to raise its standards, the West cries foul because the moves hurt their selfish commercial interests,” Chen wrote.

U.S.-based industry veteran Jack Lifton said Chen was “mostly correct.” Lifton, founding principal of Technology Metals Research, told The Australian that there remained a vast cultural gulf between profit-oriented Western businesses and China, where the goal was growth to raise the living standards of the masses.

“I think that China will supply its domestic industry’s needs in total and then export only the surplus, because this is how a command economy works,” he said.

Lifton said he also believed China had already cut back rare-earth element production for environmental reasons as part of a restructuring and consolidation of the sector that was now under way.

Despite the proliferation of long-term agreements signed by Western companies in the past few weeks, Lifton said it was hard to believe that “any significant production of anything other than ore concentrates will be underway by the end of 2011.”

“So I think that prices for rare earths will be set on the spot market by Chinese exporters for one or two or even three more years,” he said.

If you’re reasonably well informed about global trade issues, then you know that the USA and China disagree politically on the relative value, of the Chinese renminbi in US dollars, and that the renminbi’s exchange rate with the US dollar is set by the Chinese government. This is because the world market has chosen not to make the renminbi freely convertible (exchangeable for other currencies at a rate set by a free market, not by the issuing country). This is itself because the Chinese government exclusively sets the exchange rate, and its power to do so is based on the immense size of its trading economy surplus (of export value over import cost), and on the fact that China has now built up the world’s largest (ever in history) reserves of ‘hard’ currency (convertible to US dollars), in the form of US  dollars themselves.

These two factors allow the Chinese to keep their currency pegged artificially low, relative to the value that the free market would give it in terms of US dollars. The US government, for all of its bravado and the ranting of internationally powerless members of the US Senate, can do nothing to force the Chinese to strengthen the yuan (the basic unit of renminbi).

China is thus enjoying a powerful advantage in that it takes fewer dollars to buy a yuan, than it should if the global free market operated in China. This is because China has accumulated so much ability, not just potential, to affect the world trading (export/import) markets.

With that introduction I am going to issue a caution, perhaps even a warning, to all of those calling for sustained increased prices for the rare earths. Be careful what you wish for.

“China speeds up yuan’s globalization” is a headline that appeared in the International Business Times last week. It joins a flood of other stories on this topic, now filling the news prior to a meeting between the US and Chinese presidents in this coming week. My first thought was to wonder how this Chinese move will affect the rare-metals market.

The US dollar supplanted the British pound sterling between World War I (a war which essentially made the UK insolvent) and the end of World War II (which made the UK bankrupt). Note well, that the British Empire gave up a century and a half of economic gains in a 31-year (1914-45) effort to decide the mastery of Europe, which the combatants started out believing would decide the fate of most of the world. Southeast Asia was a backwater in both wars as far as the issuer of the world’s de facto reserve currency (the UK) was concerned, in 1914 and in 1939. In 1947, Imperial Britain had been replaced by a fundamentally still-isolationist United States, as the absolute center of the financial world. In 1947, the USA held for its own account or for safekeeping, half of all the gold in the world. No greater accumulation of gold had ever before been seen, nor has it been since, at least so far.

The Chinese Empire collapsed in 1912, in a series of  events more noticed in Hollywood than Washington, DC. Yet no Communist revolution immediately followed the fall of the last dynasty in China, as it did in Imperial Russia six years later. China literally seethed in revolutions and dictatorships until Japan, emulating European empires in their death throes, decided to create a protectionist trade zone with a complete self-sufficiency in the supply chains for metals, minerals and energy. It called its plan the ‘Greater East Asia Co-Prosperity Sphere.’ The first move by Japan was to try to conquer China, piece by piece, to get its resources and acquire control of its population for use as labor.

The Japanese were defeated in China by the USA, which belatedly came to southeast Asia’s rescue when the Japanese miscalculated the consequences of going to war, with a far-off enemy with a larger manufacturing economy. The Chinese in all their suffering, noticed the Japanese error and resolved to never let it happen to them again. Note that the Communist revolution and ascendancy in China started during the attempted Japanese conquest, which went on for 14 years! The Communists were successful in 1949 and China became The Peoples’ Republic of China, as it is called today.

America, sitting on a massive hoard of gold in 1949 and enjoying the greatest industrial manufacturing-based consumer boom  in history,ignored the devastated economy of China as too big a problem to solve in a reasonable time. It decided instead to revive Europe (and as it turned out, Japan) as a hoped-for market for American goods and services, to be paid for with cheap labor at first. Even though no- one in the McCarthy era period of anti-Communist knee-jerk political correctness would admit it, there was a feeling that the Soviet Union could and would now get bogged down for generations in China, which was seen as a basket case.

Unfortunately, many Americans of the political and economic class are basing their decisions with regard to China, as if the USA could catch up with Chinese politics and economics by simply adjusting America’s 1960s view of China.  It is too late for that.

The Chinese renminbi has now begun a journey that I think ultimately will result in the yuan and the dollar both being reserve currencies and then in the yuan surpassing the dollar as the stronger  reserve currency. This will occur in lock-step with the US reducing its ability to create wealth, through the production of natural resources and their conversion into finished goods in surpluses that can be exported, while the US maintains its standard of living.

This will probably not happen overnight; it could take a generation, because we are still in the period where Chinese investors are accumulating the US dollar as the reserve currency because they still fear using their own currency as a safe harbor, and because they have so much of the reserve currency that they are able to affect the political choices of the issuer of that currency.

The Chinese are well aware of the fact, conveniently forgotten by American politicians, that while the UK was the issuer and guarantor of the world’s reserve currency, it was also on the gold standard, and it was the world’s policeman, whether it liked it or not. Britain was the world’s policeman in order to protect its imperial trade routes. America did not take over this role after World War II. Instead, it immediately went to Cold War to prevent the ‘spread’ of communism. The greatest defeat in that Cold War was considered to be ‘the loss of China,’ although no-one suggested war either to prevent or redeem China’s ‘fall’, even when China as the newly minted PRC went to war with the US, by proxy, in Korea, which the US then, as now, refers to as a “police action.” In all fairness to the politicians of 1949 and the USA, we had just concluded a massive effort that destroyed China’s attempted conqueror, Japan, and the American people did not perceive the ‘loss’ of China as a near-term problem.

China is today still not a credible, conventional military threat to the USA. As in the Middle East, technology and training beat ill-equipped, ill-trained masses, every time. This means that militarily, without the direct and credible threat of mutual atomic annihilation, China cannot prevent the USA from acting anywhere in the world even as close to its own shores as Japan or Taiwan. China’s recent probing of Japanese resolve on sea floor rights to energy and minerals, has been cast as a rare-earth issue by myopic viewers of the international scene, and self-interested parties looking for drivers for investment in non-Chinese rare earth production. In fact, the confrontation was merely a skirmish in a larger war for natural resources, begun nearly a century ago by Japan, in emulation of Britain.

In the world of international trade of utilitarian commodities, metals, minerals, and energy sources, China is the demand driver overwhelmingly. Essentially all investment in new productive capacity for utilitarian commodities, is to add supply for serving Chinese demand. If this is a slight exaggeration, at least it is true that no-one would make anywhere near this level of investment, if it were not for the collateral of massive Chinese demand growth.

To put it mildly, China is in the driver’s seat (excuse the pun).

At the moment. China is the dominant player in the rare-earth space, which is where the operation of Western free-market capitalism, always seeking the lowest price, placed China. This cannot and will not change for two to three years, the least time it will take, if everything goes according to plan, for new or restarted production and refining in significant quantities of rare earths produced outside of China, refined outside of China, and incorporated in end-use products outside of China to come to the world market.

So, what is this to do with the value of the US dollar and the Chinese yuan?

If China continues to hold the price of the yuan where it is against the US dollar, then the only pressure to produce rare earths outside of China will be for strategic advantage to ensure security of supply, to maintain both civilian industry and military uses free of Chinese influence and control.

China today controls the rare-earth supply chain, because its price structure has moved that entire supply chain to China up to the point where high-purity metals and alloys are delivered to end users. Even there, at the point of end-use manufacturing, China is today the low-cost producer and so today, China is not only the monopoly producer of the rare earths, it is the dominant end-user of rare earths in the manufacturing of finished goods.

At least half or more of these rare-earth-containing finished goods are made in China for the export market. Therefore, it is in China’s economic interest to prevent the export of rare earths as raw materials. This has been the exact direction of Chinese export controls on rare earths since the beginning of this century.

If you believe, as the Chinese do, that the only remaining threat to their total control of the rare-earth supply chain is the Japanese rare-earth end-use products industry (such batteries, permanent magnets and lasers), then you will put pressure on Japan to move the last of the world’s non-Chinese, high-value-added sectors of rare-earth-based product manufacturing to China, or give the Japanese a reason to allow Chinese manufacturing competitors to compete in Japan (which today Japan does not do, in the case of magnets). Either of these moves would create jobs in China. which is always the goal of the Chinese economy, as it is the goal of the Japanese economy, and as it should be the goal of the US economy.

The point of all of this, is that it is China who will benefit most from price increases, for the rare earths as fabricated forms for industrial manufacturing end-use.

Chinese analysts predict that by 2015, China will produce just two-thirds of the world’s supply of new rare earths. Chinese analysts assume that Lynas, Molycorp, and perhaps, Toyota in Vietnam, will produce the remaining third.

The Chinese analyst community is silent about the overall percentage of the total value-add rare-earth supply chain that this one-third will represent.

I think that China will be completely self-sufficient in domestic rare-earth production for its supply chain in 2015 as it is today. I also think that higher prices for rare earths are inevitable as China cleans up the environment in general and in mining in particular. The one, the greening of rare earth mining, adds costs to rare-earth mining; the other, the greening of the Chinese economy, adds demand. Both are upward price drivers.

The real question is how much of the higher costs of rare earths can be absorbed by the Chinese supply chain, before increases in cost for value-add rise, to where a competitive supply chain can be economic in a foreign (to China) country other than Japan. Note that as rare-earth prices go up in China, they will also go up in Japan and that Japanese labor and overhead is vastly greater than that of China today. The gap will close, if it closes, only slowly even at Chinese rates of growth of costs. Those who think they will operate in the USA to add value to rare earths mined and refined in the USA, need to demonstrate that their supply chain total costs are below those of foreign competitors. Historically it is the very fact that this has not been so, which has driven the rare-earth supply chain to Japan and China in the first place.

China, in my opinion, has always wanted higher prices for rare earths, but has been prevented from getting them by fierce internal competition for supply from both legal and illegal sources. The elimination of unethical, dirty, and illegal competition is the target of the current consolidation and environmental remediation (of the rare earth mining sector) initiatives within the PRC.

Now, what about the value of the Yuan?

Chinese goods bought in China must be purchased in renminbi; that is the law. In order to buy or trade goods within China a foreign company must place a hard-currency deposit in a Chinese bank, as collateral for being allowed to purchase renminbi for use only in commercial transactions, at an exchange rate set by the Chinese Ministry of Finance.

So, if the Chinese re-value the renminbi up to reflect its strength as the US demands, then the number of dollars to buy the same number of renminbi will increase. Thus, without doing anything at all, the costs of Chinese goods to foreigners in the dollar/euro/yen economic zones (all of them are hard currencies exchangeable at market rates for one another), including rare rare earths, will rise, but the renminbi price will not rise just on that account.

If China, after imposing an increase in the value of the renminbi, then sees its internal rare-earth prices go up in renminbi, there will be a larger proportionate increase in the number of dollars it will then take to purchase the renminbi, to purchase the rare earths.

I believe that the cost of the rare-earth fabricated forms necessary to make end-use products in mass production, is only a small part of the final cost of the finished goods.

Therefore I believe that an increase in the prices of the rare earths in renminbi, without a contemporaneous increase in labor rates in China for workers who produce the finished goods, does not change China’s competitive advantage in the value chain for rare-earth-based products.

Unfortunately, such an increase will serve in the above case to make non-Chinese value chains even more uncompetitive, since other than in Japan, they will need to invest large amounts of capital to start or restart operations to refine, fabricate, and utilize rare earths in consumer products, and will at the same time have to train largely inexperienced engineers and workers to do jobs for which there is little or no domestic prior experience base to draw upon for instructors. Even if these barriers of capital and skilled labor are overcome, they will now have to play catch-up in technology and compete economically with long-established Chinese and Japanese industry, which has not been standing still waiting for them.

The best market plan for non-Chinese miners who plan to produce rare earths, is to acquire or JV with existing companies that already have the skill sets needed. These will be Chinese, Japanese, French, British, Indian, or Estonian companies. Some have already done this. Any mining venture that intends to go head-to-head with a Chinese mining venture, solely on the ability to produce ore concentrates or even separated and purified chemical compounds must, I think, fail.

There is also one more thing that all rare-earth end users must do. They must secure their supply of the total of the critical rare earths for their products or processes. This means to me, that they must secure their supplies of one or more of lanthanum, neodymium, samarium, europium, dysprosium, and terbium.

Since nature does not provide any one rare-earth deposit with commercial quantities of all of the rare earths, or all of the above critical rare earths, it is necessary always to choose one from ‘Column A’, a producer of the light rare earths, and one from’ Column B’, a producer of heavy rare earths. This is even true for the contemporary Chinese rare-earth-containing finished-goods industry.

The most critical of the current rare earths are dysprosium and terbium, two of the heavy rare earths, today produced only in China and historically produced only in the former Soviet Union and in China.

There are only a small number of rare-earth projects outside of China capable of producing commercial quantities of dysprosium and terbium. Some or all of these MUST be brought into production as soon as possible, because it is said by the Chinese themselves, that their heavy-rare-earth production has less than 25 years remaining at present levels, and much less if demand increases. China, like the rest of the rare-earth-using countries, is therefore also seeking out heavy-rare-earth production.

I believe that for heavy rare earths, and only heavy rare earths, strategic need will overcome simple economics, or at least the capitalization of strategic need will create the necessary economics to bring heavy-rare-earth-themed mines into production.

There will be no non-Chinese, rare-earth-based, mass-produced devices utilizing rare-earth permanent magnets, until a reliable steady supply of dysprosium can be secured. The lighting industry outside of China will founder ,without a secure supply of the heavy rare earth terbium.

Therefore, if there is to be a non-Chinese, rare-earth-utilizing manufacturing industry, one or more of the heavy-rare-earth deposits that are technically feasible, must be brought into production even if it is not economically sensible on a freestanding basis as a business.

You need to look at the TMR Advanced Rare-Earth Projects Index, produced and maintained by my colleague Gareth, as a metric to decide which rare-earth mines are going to be critical to Chinese and non-Chinese rare-earth supply chains. I am going to make my own selections in a separate article, so that I can explain to you why I chose some over others.