Is there a buying opportunity in rare earth metals? Many would say yes, but you want to be careful. The smartest thing to do at this juncture is probably to stay away.

The rare earth metals industry is mostly ignored. But every five to 10 years it captures public attention, producing wild boom-and-bust patterns as a result. The problem is the “bust” part.

The last time rare earth metals had a wild run-up, the rationale turned out to be more hype than substance. The major rare earths stock play at that time, Molycorp, rose more than 400% in the year after it went public. But then the price of rare earth metals collapsed, and Molycorp went bankrupt.

The term is actually a misnomer. In reality, rare earth metals are not that rare. Some of them are as abundant as copper and lead, and there are giant rare earth metals deposits in pockets around the globe.

China is estimated to have 44 million tons of rare earth metals reserves, for example, but Brazil and Vietnam have 22 million tons apiece. Russia has another 12 million tons, Australia 3.4 million, and the United States 1.4 million.

And Japan made a recent discovery of a huge rare earths deposit underneath the sea bed in a 965-square-mile patch of Pacific Ocean that could potentially deliver a “semi-infinite” supply of rare earth metals if they ever decide to tap it.

So, there are plenty of rare earth metals supplies. On top of that, such a tiny amount of rare earth metals are used each year — they are comparable to the yeast in bread, but for technology — the world can never run out.

The reason China dominates the rare earth metals industry, and has done so since the 1980s, is that rare earth metals are a nasty headache to mine and produce. They are tough to separate and turn into usable form, and the refinement process produces radioactive toxic waste.

The term “rare earth” dates back to the original discovery of the rare earth elements — there are 17 of them — by a Swedish army lieutenant in 1787. For more than 150 years, rare earth metals were just a curiosity. But in the 1950s and 1960s, rare earths started finding use cases in cutting-edge technology.

Over time, rare earth metals saw their demand rise as engineers figured out how to use them in everything from television screens to x-rays and to gyroscopes. Without the right dash of rare earth metals ingredients, your smartphone touchscreen wouldn’t have the almost magical properties that it does.

In the 1980s, China came to dominate rare earth metals production by two means: Low-cost labor and a lack of environmental restrictions. China could produce rare earths more cheaply than any other country, and they weren’t squeamish about the pollutants and toxic waste.

As a result, China became the dominant low-cost supplier of rare earth metals, driving the rest of the world out. At their peak of control, China supplied more than 97% of certain rare earth metals elements. Due to labor and pollution factors, nobody could match them economically.

But then, in 2010, China pushed the envelope too far. In retaliation for a naval spat with Japan regarding some disputed islands, China cut off Japan’s access to its rare earth metals supply. China was also restricting the volume of rare earth metals exports at this point, both to muscle prices higher and to convince manufacturers to relocate their operations to China.

Though the Japan cut-off was only temporary, the world woke up to China’s control of the rare earth metals market in 2010. This led to company stockpiling and a frantic effort to find alternative rare earth metals sources. The aggressive stockpiling caused the price of some rare earth metals to soar more than 3,000%.

It was against that backdrop that Molycorp, a U.S.-based rare earth metals play, went public and ran up more than 400%. But then prices collapsed — in part because the stockpiling panic was overdone, and in part because China never really went offline — and Molycorp went bust.

Japan also arranged a strategic low-cost loan for Lynas Corp., an Australian miner, to develop a non-China alternative for rare earth metals supplies. Lynas is a major non-China rare earth metals source to this day.

Today, China is rattling the saber once again, hinting loudly at a rare earth metals cut-off as a form of trade-war retaliation. That is why the share prices of various rare earth companies suddenly spiked. Lynas Corp. (LYSCF) saw its shares pop 80% in a matter of weeks, largely in anticipation that something like what happened in 2010 could happen again.

But another giant run-up in rare earths metals prices is probably a false hope, for multiple reasons.

First of all, companies learned their lesson from the 2010 debacle. The huge price run-up that happened back then was largely due to stockpiling panic, which wasn’t really necessary.

At the same time, rare earths are not easy to wield as a trade-war weapon, and any attempt to cut off the United States could backfire badly on China.

The U.S. only imported about $160 million worth of unfinished rare earth metals last year, a tiny amount. America’s far larger demand for rare earth metals comes in the form of finished products — like the magnets that are used in everything from headphones to airplanes, or the glass in smartphones.

This means that, for China to truly use rare earth metals as a trade-war weapon, it would have to cut off a large flow of finished products to the United States, not just the direct mining products. This would not only hurt China’s local industry, it would hurt many of China’s trading partners who convert rare earth metals into finished products. The global supply chain is incredibly complex.

That is why the observation that “rare earth metals are used in hundreds of high tech products” is a red herring when it comes to assessing the actual threat level to the United States.

It is true that the product distribution for rare earth metals use is widespread. But it remains just as true that China would be foolish, possibly insane even, to wreak havoc on its own industry players and its own supply chain partners, especially in the context of gearing up for a multi-year or even multi-decade confrontation with the United States.

In the longer term, China is going to need all the allies and supply chain partners it can find in its confrontation with the West. That need would not be helped by acting like a wrecking ball.

Not only that, trade hawks in the United States are actually rooting for China to play the rare earth metals card. That is because, if China does this, the hawks will have a stronger case in pushing American companies to bite the painful bullet on relocating their supply chains to ABC — Anywhere But China. This would be a costly headache, but it would accelerate the economic isolation of China.

Then, too, other rare earth metals suppliers are preparing to step into the vacuum. The rare earth metals industry got an adrenaline boost after the 2010 wake-up call, and now there are real alternatives to China’s dominance of rare earth metals supply, which by some estimates has dropped from as high as 97% down to 71%.

There are also plans to reboot Mountain Pass, the sole rare earths processing facility in the United States that was mothballed after the last boom-bust cycle, and to start up a new rare earth metals processing facility in Texas.

In addition, if the price of rare earth metals skyrocketed for any length of time, Japan would have incentive to start exploring the seabed where a “semi-infinite” supply has been located. If rare earth metals prices stay reasonable, on the other hand, Japan would not have the economic rationale to take the trouble.

All of this means that, when it comes to the rare earth metals threat, China is probably bluffing.

Any attempt China makes to weaponize the rare earth metals supply — after trying it less than a decade ago — would badly harm its reputation, hurt its own key trading partners as much as (if not more than) the United States, and spur a permanent build-up of new competitive supply.

All of this means that chasing after rare earth metals stock plays right now is likely not a wise move.

For example, Lynas Corp. (LYSCF), the Australia-based rare earth metals play seeking to develop a facility in Texas, could have a bright future.

But Lynas could also be subject to more profit woes if the price of rare earth metals calms down again. And with an 80% jump in a matter of weeks, much of the knee-jerk optimism is already priced in.

Similar issues exist for REMX, the Van Eck Rare Earth Metals ETF, which saw a burst of bullish activity on word of the China threat.

If China is bluffing on its rare earth metals threat — and this is the base case for reasons we just explained — REMX could decline sharply when reality sets in.


Founder, TradeSmith