Why Contrarians Say China's Rare Earth Trump Card May Backfire

China is regarded by many experts as holding a trump card in trade talks given its dominant position as a global supplier of rare earth materials used in U.S. industries including technology, aerospace and defense. The U.S., in fact, relies on China for 80% of its rare earth supplies and China has made veiled threats that it may restrict exports to American companies. “If China wanted to reduce exports of rare earths, the logical step would be to lower the mining quota,” Helen Lau, a metals and mining analyst at Argonaut Securities told Fortune magazine recently. She said China may signal its intentions as early as this month when it decides on quotas.

But a move to restrict exports to the U.S. in 2019 could backfire, according to analyses in separate columns in both the Wall Street Journal and Barron's. For starters, when China restricted its exporting of rare earth materials in 2010 and prices rose, foreign capital invested in mines in other parts of the world. As a result, per the Journal, China's share of global production dropped from nearly 100% to 70% today.

Why China May Lose If It Plays Rare Earth Trump Card

  • China's market share already has fallen from 100% to 70%
  • U.S. tech companies can find workarounds to get material
  • A large share of U.S. demand is not strategic and can be replaced
  • New suppliers such as Brazil, Australia are emerging

Source: Wall Street Journal, Bloomberg

What It Means for Investors

China's sales also fell because giant U.S. tech companies were able to develop workarounds by using materials that were more easily accessible. They are likely to do the same this year if China cuts supplies.

It's also overlooked that much of the demand for these elements in the U.S. is not strategic in nature, per the Journal. Rather, about 60% of rare earth materials are used as catalysts, a fairly basic application. Only about 1% of rare earth material demand in the U.S. goes to the Department of Defense. According to a report by Fortune, American demand for China's rare earth exports is actually quite low, accounting for just 4% of China's shipments in 2018. Because, paradoxically, rare earth materials are typically not so much "rare" as they are costly to mine, operations in other regions including Brazil, Australia and Vietnam are aiming to wrest away some of China's control over the industry.

If China plays its trump card, companies in the U.S. and abroad will be ready. In 2010, prices on rare earth materials spiked, hurting some companies in the short term. But in response, CEO Robert Macleod of British catalyst producer Johnson Matthey, said recently that his company learned new lessons from 2010, per Barron's. Now, the company has "multiple sourcing options," said Macleod.

What's Next

To be sure, these analyses my end up being too bullish. Skeptics suggest that China's monopoly over these materials could pose a significant threat to U.S industries. Jack Lifton, Technology Metals Research co-founder, described the potential impact of a restriction on exports from China as "devastating," per Bloomberg, adding that it "would be a tremendous hit to the consumer appliance industry and the automotive industry."

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