Hiba Mouallem
Hello and welcome to another weekly podcast by BNP Paribas Wealth Management. I am Hiba Mouallem, Investment Strategist, and I'm joined today by our Global Chief Investment Officer, Edmund Shing, to discuss rare earth elements.
Hello Edmund.
Edmund Shing
Hello Hiba.
Hiba Mouallem
Edmund. Rare earth elements, or rare earth metals, are composed of 17 elements that can mainly be found in clay and rocks. They are extracted, then processed and refined in order to be used in several products, such as technology and even defence equipment. Lately we have been hearing and reading a lot about these metals. Why are we focusing on them today and what are they? What do they do?
Edmund Shing
Well, as you said, Hiba, rare earth metals are a series of 17 different metals and elements, and they are important in a range of technologies you mentioned there. We can talk about semiconductors, such as elements found in your laptops, your smartphones, obviously in defence equipment as well. You know, this can be in all types of armament as well, and all types of electronics. So they are actually fairly crucial. Now the problem: why have they become so important today? Why have they come into focus? Well, obviously there's this huge rage about the increase in spending on defence. Secondly, the increase in spending, particularly around AI, the CapEx around AI, which implies an increase in demand for rare earth metals.
Now, at the same time, what we know is that 90% of the refining of rare earth metals is done in China, which means the rest of the world only controls 10% of the refining capacity of rare earth metals. To recall, rare earth metals aren't actually that rare to find. But it's the refining capacity where you see a real bottleneck. And there, China has a near global monopoly. And of course, given the geopolitical tensions with China restricting the exports of both rare earth metals and products related to rare earth metals such as magnets, such as those magnets used in wind turbines, this has become a big problem, particularly for countries such as the US, who are now threatening to increase tariffs on China if China does not back down on these export restrictions.
Hiba Mouallem
Thank you Edmund. So as you mentioned, rare earth elements are not that rare. However, we know that their production and reserves are mainly based on a number of countries, mainly China, as you said. So we know that although they are not expensive, it's their production and refinement which are a costly and lengthy process. How was China able to position itself as a major actor in everything related to those elements?
Edmund Shing
Well, through heavy investment over a long period of time, first of all. Let’s not forget that with rare earth elements, you have to process an enormous amount of underlying clay ore or rock ore in order to extract a very small proportion of rare earth metals. So you have to process tonnes and tonnes of material to get a few kilograms of rare earth metals at the end.
So it's very energy intensive, and it also could be quite polluting if you're not careful. And that's why it requires a lot of investment, because you have to process an enormous amount of underlying ore as an input in order to get, as an output, a very small quantity, relatively, of these rare earth metals, because they're present in tiny proportions of the underlying ore body. So that's the issue.
And really because of the expense of the investment and because, frankly, the cost of rare earth metals wasn't high enough for most companies to justify the sort of investment needed, only the Chinese went ahead and, in particular, invested the massive amounts required to build up the refining capacity for these rare earth metals. And as such, that's why today they control 90% of the output because of this bottleneck and refining, simply because they were prepared to invest massive amounts of money over a long period when in the Western world, we were simply not prepared to do the same thing.
Hiba Mouallem
Noted. So you were mentioning at the beginning that there is a growth of demand because the rare earth metals are available in several products. So several countries have been lately considering the rare earth metals as critical minerals due to their strategic and economic importance as per each country's consideration. However, with China dominating rare earth metals and production, we are currently seeing tensions between the United States and China related to those elements. Could you provide us with more details? How is the trade tension impacting the prices of rare earth metals?
Edmund Shing
Well, rare earth metals have clearly gone up, particularly in the Western world, because so little actually exists. And at the same time, as we've said, underlying demand from technology and from defence manufacturing is increasing quite considerably. And that's not to mention renewable energies where something like neodymium, which is one of those rare earth metals is a key component in the large magnets required within wind turbines to actually generate the electricity when the wind turbines actually turn.
The US have put in place a strategic programme of heavy investment, and it's likely that the US, led by the US government, who have actually invested directly into some rare earth metal-producing companies, such as MP Materials in the US, it is clear that there is a huge investment worth billions of dollars going into domestic production and refining of rare earth metals in the US, in North America in order to combat this overreliance on China for the supply of rare earth metals and elements related to rare earth metals, like, of course, batteries and these very powerful magnets.
But on top of that, you do need things. You do need other materials like antimony, which is another rare earth metal use, particularly in the defence industry, for hardening so it hardens. It's something you add to metal alloys to harden them up, to make them super hard, which is of course very important with things like bullets and missiles.
So the importance of something like antimony cannot be understated, particularly as the Western world looks to ramp up defence spending, in fact, to rearm; Even if we do get a ceasefire in Ukraine, that trend in defence expenditure clearly will not change and will continue to increase over the next few years. And as such, the demand for these rare earth metals will continue to increase. And that's what creates these tensions, because at the time when demand is increasing, China is seeking to restrict the supply of them to anywhere outside of China.
Hiba Mouallem
So, Edmund, you are mentioning that there will be an increase in the prices of rare earth metals. And also we can note the example of a few days ago, the deal signed by the US and Australia, which has also led to a surge in the prices of those metals. So, Edmund, do you think that the supply of rare earth metals will follow the demand? Do you think investing in rare earths is a good opportunity now? And if so, where should investors look to?
Edmund Shing
I think it is a good investment opportunity for the next few years. This is not forever, because as we know, if demand continues to grow and prices go up sufficiently, eventually supply follows because companies do make the investment to increase the production of rare earth metals, to respond to demand if the prices are sustainably high enough. Now, one key element regarding the strategic investment of the US into critical and strategic minerals production is that they are guaranteeing a minimum price for many of these materials. So as such, as I was saying, we will definitely pay at least this much per kilogram for each of these critical minerals in order to make sure that they get produced. To say to the manufacturers “Look, we have backstopped your profitability” because one of the elements with rare earth metal production and one reason why companies are so unwilling to invest is because the cost of CapEx is very high. And then the return on that investment is very uncertain because the prices historically have been very cyclical. You only need to look at the history of something like lithium, where you have either prices rising very sharply or then crashing sharply as well thereafter, which means that the pricing environment is very unstable and therefore very uncertain. And that's why companies typically are reluctant to make these heavy investments, because of course, they have to make these heavy investments over, let's say, 5 or 10 years, and who knows what prices they will achieve for the metals at the end of it, unless in this case, the US government guarantees the minimum price?
Hiba Mouallem
Okay. And where should investors look it if they want to invest in rare earth metals?
Edmund Shing
Well, there aren't so many options. I think the obvious way to invest is using funds and ETFs of companies that produce and refine rare earth metals. And these can include, of course, companies based in the US. There are some companies in Europe as well, and of course companies in China and elsewhere in Asia. So the funds and ETFs typically invest globally in production and refining capacity all around the world. And that's what I would suggest, because there you get a sort of a good, diversified mix of exposure through these funds and ETFs into the range, not just one of these metals, but into all 17, the production of all 17 metals. And you might even include others beyond that. You might even include silver, copper and lithium, which are though not that uncommon, are still seeing demand growth and restrictions on supply.
Hiba Mouallem
Perfect. Thank you very much, Edmund, for all the information. And thank you to our audience for listening to this podcast. Please like, share and subscribe to our series of podcasts. Until next time, goodbye.