Olemedia/E+ via Getty Images
Olemedia/E+ via Getty Images
Demand for strategic rare-Earth metals is booming due to strong demand from the EV and green energy sectors as well as the demand for critical permanent magnet components. Yet the global strategic rare-Earth investment sector is difficult for the average ordinary investor to navigate because many of the leading producers reside in foreign countries. That being the case, investors may want to consider the VanEck Vectors Rare Earth/Strategic Metals ETF ( REMX). Unlike the VanEck Russia ETF ( RSX), that has been a complete disaster for investors and for which trading has been halted since March 4th (with no end in sight...), the REMX ETF has no exposure to Russia. That being the case, let's take a closer look at the ETF and determine if it might be worth an allocation in your portfolio.
The rare-earth metals market is projected to grow from $5.3 billion in 2021 to $9.6 billion by 2026, at a CAGR of 12.3% during the forecast period. The increasing use of rare-earth elements that are used in the permanent magnet application are likely to drive the rare-earth metals market. APAC (Asia Pacific+China) is the fastest-growing market for rare-earth metals due to increase in production and consumption in China. Significant usage of permanent magnets offer a huge impetus to these advanced materials, are expected to drive the rare-earth metals market in the region.
Permanent magnets - and the rare-Earth elements required to make them (neodymium, praseodymium, dysprosium, terbium, and yttrium) - are critical components in such various applications as leading-edge military and civilian aircraft, industrial motors and generators, and consumer goods - almost all of which are supplied by China or Japan. But the vast majority of rare-Earth magnets, alloys, and catalysts come from China, which has a near monopoly in the sector as well as in rare-earth-enabled component manufacturing. That flow from China has been slowing and could have a crippling effect on various U.S. and European industries.
As a result, in February of this year President Biden announced an initiative for Securing A Made-in-America Supply Chain For Critical Materials. That follows a year-earlier Presidential executive order (Executive Order 14017 (E.O.), America's Supply Chains) after the Biden Administration released a first-of-its-kind supply chain assessment that discovered that America's over-reliance on foreign sources and adversarial nations for critical minerals and materials posed a distinct and present threat to national and economic security. These actions alone point out the level of criticality that securing rare-Earth and strategic metals and is a bullish catalyst for the miners that produce them.
With that as background, let's now take a closer look at the REMX ETF to see how it has positioned investors going forward.
The top-10 holdings in the REMX ETF are shown below and equate to what I consider to be a relatively concentrated 61.4% of the entire portfolio:
But I suppose that is logical considering the portfolio only owns 20 companies in total due to the fact that there are just not a lot of companies operating in the rare-Earth and strategic metals sector (i.e., these elements truly are "rare").
The #1 holding is Australian-based Allkem Ltd. (OTCPK:OROCF). Allkem produces lithium and boron from its flagship Olaroz Lithium Facility located in northern Argentina. Judging by its demonstrated and expected revenue growth, business is booming:
Two Chinese companies, and one Hong Kong company, account for 19.1% of the top-10 allocation and produce cobalt, rare-Earths, and lithium.
Two US-based companies, Livent Corp. (LTHM) and MP Materials Corp. (MP) account for ~10% of the portfolio's holdings. Livent produces performance lithium compounds primarily used in lithium-based batteries, specialty polymers, and chemical synthesis applications. The stock is up 73% over the past year.
MP is based in Nevada and operates rare earth mining and processing facilities. It owns and operates the Mountain Pass Rare Earth mine and holds the mineral rights to the mine and surrounding areas. MP also owns IP rights in the field of rare-Earth processing and development. The company produces cerium, lanthanum, neodymium, praseodymium, and samarium. MP is up 43% over the past year and trades with a forward P/E=29x.
In terms of the entire portfolio, the geographical allocation is as follows:
As can be seen in the graphic, the REMX ETF has its largest exposure to Australia (40.8%), a Democratic American ally - as are all the other countries with the notable exception of China (26.3% of the portfolio). The ETF's currency exposure is similarly aligned. The good news here is no direct exposure to Russian equities.
The long-term performance of the REMX ETF is shown below:
As can be seen in the graphic, the 10-year performance of the fund is rather pathetic - and, indeed, negative. However, the 3-year and 5-year performance is excellent. My take is that investors should consider that rare-Earth and strategic metals have recently hit a higher-level of strategic awareness given the combination of growth of EVs (and the required lithium supply) and the US/China trade war. As a result, returns going forward are likely, in my opinion, to display more similarity with the recent past as compared to 10-years ago.
The REMX ETF is not immune to the global macro-environment that almost all investors are now fully aware of: continuing pandemic related shut-downs and supply-chain disruptions, high inflation, the outlook for higher interest rates, and Putin's horrific war-of-choice in Ukraine and the resulting sanctions placed on Russia by the United States and its Democratic & NATO allies that have, combined, effectively broken the global energy & food supply-chains. Any and/or all of these developments could lead to slower global growth or even a global recession that could cause demand destruction for rare-Earth and strategic metals. However, my instincts tell me that even if there was a global recession, demand for rare-Earths would remain strong because they are so vital to so many various key strategic industries.
American investors need to be comfortable with the foreign exchange risks associated with REMX's exposure to currencies from other countries. That said, for an investor wishing to construct a well-diversified portfolio built for the long-term, having some percentage of the portfolio exposed to foreign currency could be considered a key component of that diversification strategy.
China, and a worsening of the US/China trade war, is likely the biggest risk to the REMX portfolio. If China chooses to nationalize its rare-Earth companies and de-list them from foreign investors, that would obviously create a high-level of risks for an ETF that has 26% of its portfolio allocated to China-based companies. As Barron's reported last year:
China has about 70% of the world's known rare-earth reserves, the most in the world, says Brodrick (Author's note: Sean Brodrick is a natural-resource expert and editor at Weiss Ratings). China has also announced that it will boost its mining quotas in the first quarter of this year by nearly 30%, which indicates "strong and rising demand," he says. With its tight grip on the world market for rare earths, it's no wonder that China has taken advantage of that in the past, and considered restricting exports in its trade disputes with the U.S. The World Trade Organization found in 2014 that China had set limits and duties on rare-earth exports that breached the group's rules.
However, investors should also consider that if China were to delist its companies and/or further restrict exports, prices would likely go up and the other companies in the REMX ETF would likely appreciate in value and therefore potentially largely mitigate the overall impact.
Lastly, many of the mines operated by western companies are located in relatively volatile and unstable countries that face geopolitical risks that are local in nature and have nothing to do with China.
While national security and economic considerations paint a very bullish narrative for the future of rare-Earth and strategic metal producers, investing in them does not come without substantial risks and is therefore not a sector suitable for many ordinary investors who are unwilling or unable to expose themselves to such risks. However, as we have seen over the past three years, REMX has delivered a 33% average annual return. That has greatly outstripped the performance of the S&P500:
For that reason, and due to the bullish strategic nature of rare-Earth and strategic metals moving forward and for decades to come, I rate REMX a BUY.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Short position through short-selling of the stock, or purchase of put options or similar derivatives in REMX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am an electronics engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.