Out of Your Element?
The rapid expansion of the vital rare earth metals market has resulted in a largely unregulated and opaque industry. Christopher Silvester digs deeper
UNLESS YOU'RE DOWN a mine, you’ve probably heard of companies touting rare earth metals as an exciting new asset class, the latest fashionable theme for retail investors who are lured primarily by promises of returns that often seem too good to be true. Indeed, the rare earths investment story is a relatively new one.
Until about eighteen months ago, no such investment companies existed. Rare earth elements (REEs) were traded exclusively by miners through wholesale brokers to industrial end users, and retail investors were not expected to get involved, meaning that rare earths represented a pure commodity play based on supply and demand.
REEs consist of seventeen elements that are difficult to extract from the earth’s surface — hence their rarity — but are used in the manufacture of everything from aerospace components and nuclear batteries to household objects such as energy-saving light bulbs and self-cleaning ovens.
China is responsible for about 90 per cent of global supply of REEs, and because the Chinese have been curbing exports of REEs and stockpiling them in recent years, prices have risen by enormous percentages, though they can just as easily fall by 20 per cent in a month, so a long-term investment perspective is required.
Yet the long-term macro-economic picture is encouraging for investors. For example, Gareth Hatch of Illinois-based Technology Metals Research believes that there will be a critical shortage of dysprosium, which is used in industrial magnets, in the near future.
LONDON HAS RAPIDLY emerged as the global capital of retail investment in REEs. Companies such as London Metal Group (which says it is ‘the world’s leading specialists in trading rare earth metals’), Metals of London (which calls itself ‘the UK’s leading specialist in rare earth metal investments’), London Commodity Markets, Rare Earth Metals Exchange, Invest in Metal UK, West Pier and CG Mosander (named after the scientist who discovered four REEs back in the 1840s) boast addresses in Canary Wharf, though these are often merely accommodation addresses.
Some tell you that they use ‘an FSA-approved money-handling and escrow account’, which means little more than that your money will pass through a bank account somewhere. Others admit in their terms and conditions that investments in rare earth metals are unregulated by the FSA. Just as with carbon credits, REEs is an area of investment requiring extreme caution.
Most of these investment companies seem to be agents for a single company called Denver Trading, a rare earth metals supplier which has been operating since 2008 and has its headquarters in Zurich. Denver has partnerships with Steiner Metals AG and Hefa Rare Earth Company of Canada, which obtain REEs from Baotou, one of the biggest Chinese mine operators. Hefa’s end-user clients include such high-profile names as Nasa, Siemens, Mitsubishi and BASF.
‘Denver has no interest in retail investing as such,’ says Chris Strauss, a Denver marketing consultant. ‘Certain commodity firms told us they wanted to deal in our product, so we said we’ll provide the product, import it for you, warehouse it, verify it, but we’ve go not interest in talking to the public. We handle the fulfilment side of things only.’ Denver warehouses its REEs in bonded facilities in Zurich and London, and clients of its agent companies are welcome to visit these facilities to view their holdings, which are audited by Nordex Financial, an FSA-registered company.
‘Investors have a contract with Denver directly and they have a certificate of ownership issued by us, which has all their references. All the oxidised metals are in 1kg or 2kg bags, so they’re individually packaged and labelled. Hefa supply the REEs to us. A unit comes into Heathrow and goes straight to our bonded warehouse, and that’s where it stays. They’ve verified it, they’ve supplied, they know the purity.’
SO MUCH FOR the security of an investor’s holding, but what about an exit strategy? ‘If dysprosium is trading at $7,000 a kilogram in four years’ time, and we know you’ve got stock, and we’re prepared to buy that back at $5,500 a kilogram, we’ll do that,’ says Strauss. ‘Because it’s good for us, it’s good for the clients, it’s good for everyone. If your intention is to take some dysprosium and stick it under your bed, do not do this as it will become valueless.’
In effect, the business model is one whereby individual retail clients act as proxy owners of physical stock for a major international trading company. When the time comes to sell, Denver arbitrages the price, acting as a market maker.
‘Provided clients are happy to exit below market price, obviously having made a reasonable profit, this can be an attractive investment. We quote three to five years as the optimum holding period. If a client wants to buy REEs and trade out in six months’ time, forget it. There are big costs involved. We pay for the warehousing for five years, there’s the insurance, there’s the verifying. The investment needs to be left for a sensible amount of time.’
The principal risk involved in investing through Denver is not that you might forfeit your physical stocks if it were to go out of business, since these are held in bond in your name, but that you might forfeit the route to market.
While the prospects for the prices of critical rare earth elements look good, it’s always possible that the Chinese might release stockpiles into the market, depressing prices, or that countries other than China might develop new sources of supply. (Vietnam has done a deal with Japan, for example.) Some manufacturers who are anxious about rising prices are seeking new methods of production that will no longer require rare earths. Still, next time you use your iPhone, which relies on rare earths, consider whether you could be making some money from it — not just Apple.
Illustration by Maggie Li