The Chinese Yuan, Rare Earths And The Selection Of Critical Mining Projects

by Jack Lifton on January 16, 2011 · 14 comments

in China, News Analysis, Rare Earths

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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.

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1 robert olson January 16, 2011 at 1:48 pm

Jack Lifton, thank you for your excellent technical analysis.

Yes please have Gareth and yourself send me “your selections” regarding the all important non Chinese sources of the heavies, especially Dy Tb and Y.

As an investor I want to support those companies best able to provide those scarce heavy rare earths, even if those companies time to mine framework is longer.

Further, I agree that the non Chinese rare earth industrial manufacturing communities ability to be reassembled have many hurtles.

However, I also believe that last fall’s Chinese Transparency of Monopolist Intent is a Industry changing event.

Never will “price point” dictate. International Security is.

All your points on the Renminbi are well stated.

Non Chinese rare earth miners and the related industries you describe shall find funding and support for development as never before.

How can I learn more about public companies in the rare earth specialty space?

Kind regards,

Dr. Robert Olson
1508/1 Courthouse Lane
CBD
Auckland New Zealand 1010
renderus@gmail.com

2 Jim Bond January 16, 2011 at 2:05 pm

Hi Jack:

Very cogent article and reasoning; Pity the politicians in Washington and the short sighted types on Wall Street won’t read and pay attention to it.

It will be very interesting the next few years to see if there is any real strategic attention paid to these issues or simply the knee jerk reaction that we can buy any thing we need or want because we want it. Acerbated by the mind set: we are a knowledge economy and need not manufacture or produce anything but bits or bites and everybody can live well by inhabiting an office in Washington DC, NY or LA and punching a keyboard or trading paper.

I suspect that there may be some strategic thinking in DOD and a few other places but doubt the political will or vision to make it happen. Not to mention all of the legal and political issues: such as the position some REE companies are now taking; we got our position, now we want the government to protect that position by handicapping and obstructing our potential competition. Via the enforcement of environmental and competition regulations ie rent seeking.

3 Jack January 16, 2011 at 2:24 pm

It seems to me that everyone is talking about Rare Earth Mines without significant by-product revenues. Kennecott mines Copper and the gold, silver, molyb,ect are profit.Would this not hold true for Rare earth mines with significant by-products?

4 Daniel Vasquez January 16, 2011 at 2:58 pm

Jack, another most excellent article. I’m totally in agreement with holding what are likely to be the most viable LREE and HREE companies. I’m not terribly sophisticated in these matters and my holdings have been whittled down to MCP, AVL and QSURD from the six companies whose stocks I originally owned. I certainly am open to adjusting my holdings and look forward to reviewing Gareth’s choices, and yours.

Thank you so much for another thoughtful and well-reasoned article on the what has become the HOT rare earths sector.

5 Ruediger Haberland January 16, 2011 at 3:13 pm

Excellent analysis of some flaring problems of todays world economy.
These are the results of the dogma of “free trade is best for everyone”.
(no dogma seems to be true and a good basis for rational decisions, nor this if one side determines the value of currency by the market and the other one by politics.)
Maybe the artificial Yuan/$ course may be counteracted by a new tax that is calculated by the ratio of salaries of any two trading nations and their unbalance in import/export.
Concerning the growing use of magnets:
Some manufacturers have the option to switch back to ferrites or AlNiCo magnets – all those that do not fight with weight limitations as generators for wind-turbines. Also copper for conductors can be switched to aluminum in these.
This may slow down a bit but not really limit the race for higher prices.
Afteror parallel to the run to establish new mines there will be a run to develop better extraction and purification technologies.
Not at all clear to me (please comment if anybody knows): will the byproducts of uranium decay put a heavy burden on those manufacturers that process ore with a significant content of uranium or thorium? And: if so then at which level starts this critical content?
RHABE

6 Nicholas Matwiyoff January 16, 2011 at 4:43 pm

Jack: Thanks for more food for thought. A number of questions have been raised by your essay and the comments on it thus far. The following comments may be helpful in addressing some of them.
Thorium and Uranium impurities can present an enormous problem in the mining, cracking, and concentrating the ore for the separation processes which, in turn, can result in a proliferation of thousands of tonnes of solvents contaminated during the separation of the individual rare earths. Those interested should: consult the history of the shut-down of the Mountain Pass operation some years ago; the public relations experiences of Arafura in Australia; and the experiences of Lynas with its nascent RE “refinery” in Malaysia.
The saleable” by-products” question has been addressed successfully by Australian RE companies Arafura and Alkane. There are many mineable multi-metallic (no joke intended) RE deposits in Australia. Indeed Alkanes Dubbo Zirconium Project was initially valued for its namesake (See also Northern Uranium).
Stans Energy, I feel, is highly undervalued for its well researched and documented HREE deposits and it should be in production (existing infrastructure and shared experience with, and consultation by, the former Russian owners). A good, balanced basket of REE investments, in my view, would be AU:LYC,AU:ALK, AU:ARU, and CA:RUU.
I think Australia, under leadership of LYC, ALK,ARU and ANSTO has the problem of the problem of the separation of the individual rare earths pretty well in hand, including the design and operation of pilot plants. The latter is a must, a situation that the Canadians and the USA has not yet really come to grips with.
TIME! Cheers

7 Gordoh Clarke January 16, 2011 at 4:46 pm

Can’t Steenkampskraal(GWMG) efficiently store their thorium in cement and offer their storage capacity to other regional REE mines?

8 MichaelN January 16, 2011 at 4:47 pm

Wonder what you see for possibilities to manufacture (i.e. via nanotechnology) replacements for rare metals.

Enjoy your commentary!
Michael

9 overpar January 16, 2011 at 4:51 pm

Very nice article Jack, you really gave me/us a lot to think about. I for one appreciate the time and effort you put into your work which you so freely share.

10 fran January 16, 2011 at 9:53 pm

your message does not change. will the gnomes in OECD capitals hear; the tokyo gurus have yet to respond.

11 Aat Oskam January 17, 2011 at 5:22 pm

Jack, as always, an article to be proud of!

But aren’t you leaving out the Eurozone too quickly? The figures show that the Eurozone has a bigger GDP than the US. Even China (and Russia) have their own reasons to suggest to use the Euro in stead of the (US)Dollar as the world standard.

Your thoughts please?

Greetings from Holland, Aat

12 Jack Lifton January 17, 2011 at 9:11 pm

Aat,

Some quick thoughts:

Thank you for making me think about this. You’re right. I just saw today the same figures for GDP that you must have seen showing the Eurozone GDP being slightly larger than that of the USA. Although the Eurozone’s population is 50% larger than that of the USA, so that its GDP/capita is 1/3 less than that of the USA both are still towering over that of China on a GDP/capita basis.

I think that the world financial markets believe that the Euro is not yet politically stable enough to be “the” reserve currency. However I think that the Chinese by taking their recent actions in the Spanish market, for example, are telegraphing to the financial community that they are betting on the continuing existence and ultimate staying power of the Euro.

I also think that we may well going towards a world of three “reserve” currencies, the US dollar, the Euro, and the Yuan. This would continue until the GDP of China, per capita, is closer to that of Europe or the USA at which point the Chinese GDP, in gross, will be multiples of that of Europe or the USA. Sometime in that period the yuan would become the world’s reserve currency but only if it is then freely convertible.

Note well that China is now the world’s monopoly producer of rare earths and that China only sells rare earths, or anything else , for Yuan, the exchange rate for which it sets unilaterally. Thus for all intents and purposes the rare earth market is, de facto, denominated in Chinese yuan. The big question is will China take action to continue this situation when and if there is significant production of rare earths outside of China or outside of its economic control. China will dominate rare earth production by volume into the indefinite future, and it will always price its rare earths in yuan. I firmly believe that China will also always be the largest demand market for rare earths, so that if the day comes that it cannot meet that demand domestically and it then must buy in the world market then that day will be the first day that the market price of a rare earth in a currency other than the yuan matters.

China fears inflation more than anything else, and commodity price inflation in particular, and so long as its domestic economy is self suffcient in rare earths it will not allow internal rare earth prices to soar uncontrollably. This is one reason why China is cracking down on illegal mining and export; it knows that high prices for rare earths outside of China will tempt Chinese prodcuers to export as much as they can.

There is a good chance that China is restructuring its domestic rare earths market to increase production, so that it either can or threaten to increase exports and thus maintain its control of the rare earths as a yuan denominated commodity. This would eliminate outside pressure to increase the internal prices of the rare earths.

Thanks again for making me think,

Jack Lifton

13 Optionsgirl January 18, 2011 at 12:12 pm

Jack, it seems to me your article argues for an investment in RMB as well as REES.
OG

14 ellwodo January 19, 2011 at 4:07 pm

A very astute article. I was leaning in the heavy REEs direction before, and you have given a superb theoretical framework for the reasons to do so. I am really looking forward to seeing your “own selections”. Theory is interesting, but as an nvestor I am even more interested in the application of a good theory.

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