Rare Earth Prices Partly Hinge On China’s Economic Health

China’s spectacular economic growth and transformation into an industrial power house has made it the first or second largest consumer of a range of industrial commodities, therefore its economic health has a very large bearing on commodity prices, including those of rare earths.

And clearly the pace of economic expansion in China is slowing and this begs the question over whether it will have a hard landing or will be able to orchestrate a managed slowdown.

A hard landing scenario, brought on by for example the banking system imploding under the weight of dubious real estate loans, would likely send prices of most industrial commodities, such as oil, coal, gas, steel and copper along with many minor metals into free fall

On the face of it, the same should apply to rare earths, prices of these materials are already lower on reduced consumer buying. However, China controls over 95% of world rare earth supplies and is determined to ration exports and could apply even more stringent measures to reduce output if rare earth prices went into free fall.

How effective those measures would be in a crisis situation where companies would try and sell stocks by any means in a desperate bid to build cash balances is another matter.

Therefore cash strapped producers faced with declining domestic demand and credit issues with local buyers could still try and export rare earths through any means possible and prices would consequently weaken on world markets.

But what are the chances of a hard landing in China?

It’s probably one of the biggest questions that divides opinion among investors and economists right now and both sides can make strong arguments for their case.

This division is exemplified by two very successful British fund managers, Anthony Bolton of Fidelity who is a China bull and the very outspoken and contrarian investor Hugh Hendry of Ecletica who is bearish on the country’s economic prospects.

The bulls argue that China has reserves of around $3.2 trillion, has relatively low national debt, a very competitive economy and can deploy vast fire power to pump up flagging economic activity. It is rebalancing its economy from exports towards domestic consumption where there is very considerable growth potential. Also, the Chinese authorities have anyway orchestrated the current slowdown by forcing banks to carry higher reserves – measures, which could be reversed if the economy was to seriously deteriorate.

And besides GDP growth of around 9% is still impressive and by not having to please voters, China can take whatever measures it deems necessary to stimulate the economy

But the China bears are having none of it. They point to China’s vast investments in infrastructure as unsustainable in the long run. Over investment leads to ever lower returns and wasted capital, they argue. Boosting fixed asset investment in the face of a downturn will actually delay the necessary rebalancing of the economy towards consumers, they say. And whereas debt ratios of the country look fine, argue bearish economists, those of local government are a different story and if their debts are included China has a GDP to debt ratio of around 74-75% and possibly a 100% if loans to state enterprises are included, many of which are poorly run.

But maybe the biggest elephant in the room is the real estate bubble often characterised by China’s empty cities. Watch these two extraordinary short documentaries: China’s ghost cities and Ordos.

Economists reckon over a quarter of China’s GDP could be tied up in real estate and prices are falling. JPMorgan estimates they could fall 5-10% over the next 18 months and by 20% in some major cities, though other economists think it could be far worse.

A big fall in real estate prices would hit the banking system hard through direct loans to the sector and indirect exposure via the shadow banking system, which has boomed on the back of government actions to curb bank lending. Many local governments would be hurt as they get a lot of funding from land sales, which would dry up.

Credit Suisse analysts recently said that loan losses at Chinese banks could hit the equivalent of 60% of their equity capital if real-estate companies and local governments fail to repay debts.

If there was a widespread real estate crash its hard to quantify the magnitude of the domino effect that would have on the country’s banking system and it could be severe, say the bears

The China bulls response to this is that a correction in real estate prices is healthy and that China has long used banks and accepts bad bank debt as a way of stimulating economic growth. Also, Chinese consumers, unlike their western counterparts, tend to be far less indebted.

Clearly this is a story that is still playing out, but so far Hendry is reported to be up some 40% on his bets against China, while Bolton has had to publicly admit that returns in China have been disappointing.

It does appear that real estate speculation has got out of hand in China, but should it turn into a full blown crash, the country’s authorities do at least have some pretty formidable fiscal and monetary capacity at their disposal to deal with it.

For buyers of rare earths that still leaves a very uncertain situation as even a relatively mild Chinese economic slowdown could result in lower prices and much depends on the success of the country’s authorities in clamping down on smuggling and illegal production.

Though there have been high profile cases of illegal rare earth mines being put out of operation in China, many rare earth prices in Europe remain significantly down from their highs.

A China hard landing could be stimulative for rare earth demand

China’s position as a leading consumer of many industrial commodities including rare earths makes it without a doubt pivotal to the prices of these materials. A hard landing by the Chinese economy analysts argue would send many commodity prices crashing including possibly rare earth ones.

It would also drag down flagging western economies it is argued, but in an indirect way it could actually be quite stimulative for western economies. Significantly lower commodity prices, especially for energy, would see Western consumers, the true drivers of western economies rather than Chinese demand, have more disposable income, which is likely to stimulate growth along with lower inflation.

That would lead to increased consumption of industrial commodities as well as for rare earths as more cars and electronics goods are sold.

Also, the refrain that China’s soaring economic growth, in part assisted by India’s contribution, would save the world economy may sound a little hollow when measured against the economic facts as spelled out by the famous economist, Nouriel Roubini in an interview with the Financial Times some months ago.

If Roubini’s argument is correct, that emerging markets economies led by China, are not big enough to pull the West’s economies up, then their slowdown probably won’t drag them down that much either.

Roubini pointed out that if anything China and other emerging economies are extracting from global demand given their export orientated policies. He also questions whether they really can take over global economic leadership from the West at the moment.

Consider that according to his estimate US GDP comes to $15 trillion while China’s, even measured on a more flattering purchasing parity power basis is probably worth around $5 trillion.

Then factor in that consumption by 300 million US citizens is worth around $10 trillion, versus $1.5 trillion by 1.3 billion Chinese consumers and $0.5 trillion from 1 billion Indian consumers, according to Roubini’s estimates, and it is clear that ‘Chindia’ simply isn’t in a position to replace falling US consumption, never mind that of Europe and Japan. “They cannot be the main engine of economic growth,” Roubini said.

A protracted period of weakness in rare earth prices, though it would probably stimulate consumption is unlikely to slow substitution efforts that much, especially from countries like Japan, which has an awkward relationship with China.

However, it could curb efforts to find alternative sources of rare earths outside China, especially as fickle stock market investors would probably flee from the sector until the world economy recovered, including China’s, and once again rare earth prices soared on a lack of supply.

A mood of panic in China rare earths

Worries about falls

Worries about falls

A mood of panic is spreading among smaller rare earth companies in China, worried that they could be excluded from a new invoicing system expected to be introduced soon in China.

The selling comes on the back of speculators liquidating their positions as they fear that rare earth prices will fall further.

A raft of data from Europe and China this week pointing to a slowdown in industrial activity is not helping sentiment either.

Many traders in China and Europe anticipate rare earth price weakness persising into the first few months of the new year.

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Rare earth price outlook darkens as China struggles to curb supplies

Cerium oxide

Rare earth prices seem to be decisively on the slide, weighed down by a combination of supply factors and possibly slowing economic growth in China and elsewhere.

There are an increasing number of reports that a possible new invoicing system to be introduced by the Chinese authorities aimed at rare earth producers and would likely exclude smaller players is seeing a sell-off in material by those likely to be cut out.

This appears to be overwhelming other efforts to support prices, such as the country’s largest rare earth producer halting production for a month and increasingly virulent efforts by the Chinese authorities to stamp out illegal production and exports. Indeed, Europe seems to be awash with smuggled material at the moment, especially cerium oxide, which is seeing prices trade way below official Chinese ones and are weakening further.

Chinese dragon slowing...

On the other hand, in China, the pace of economic growth is slowing. The latest evidence comes in the form of China’s Purchasing Managers’s Index, which fell 0.8 percentage points in October from September to 50.4 %. A figure above 50% suggests expansion. Slower manufacturing output would likely translate into lower demand for rare earths – unless manufacturers take advantage of lower prices to stock up.

One of the reasons for that slowdown is apparently linked to the seemingly unresolvable Eurozone crisis and with the continent’s largest economy, Germany, in the grips of a slowdown as well. Nonetheless, there has been some pick-up in demand in Europe for a range of rare earths with buyers taking advantage of cheaper prices and possibly simply needing to replenish depleted stocks.

There’s some speculation that Japanese buying could pick up as well for rare earth elements such as neodymium.

It’s unclear whether this will be enough to support prices in the short term, but China’s determination not to see its rare earths squandered and to steadily reduce supply shouldn’t be underestimated either.

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Sky-high rare earth prices hit downstream profits

Critical or just plain expensive?

Sky-high rare earth prices, despite the recent pullback, are hitting profitability at some of the western world’s biggest companies and end-users of the metals. The latest is German car parts maker Continental which warned that it was facing headwinds due to price hikes of rare earths and rubber, according to the Financial Times today.

Throughout the year industrial giants such as Phillips have been warning of the implications of sudden shifts upward in rare earth prices.

While rare earths are a small part of the total cost of complete vehicles their proportion is higher in components, as Continental is finding to its cost. It noted that the price of dysprosium used in magnets for electric motors had risen nearly 20-fold since 2010.

This places “an extreme burden on our component suppliers. This is a new thing. Prices for rare earths were never a topic before, they were just a small cost position in Continental’s overall business,” Wolfgang Schaefer, chief financial officer, was quoted.

A lot of attention has been placed on the criticality of rare earths and the supply disruption possibilities but price is just as much an issue for downstream industrial consumers.

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Where are the consumers?

Even rarer consumers

Eurozone chaos and signs that German manufacturing is slowing may accelerate any falls in rare earth prices as the withdraw from the market by consumers caused by recent hikes in Chinese prices become more extreme.

Reports abound of an absence of buyers and lacklustre export markets. In the face of such uncertainty in the direction of prices and the global economy the natural behaviour of consumers is to withdraw from the market and buy on a hand-to-mouth basis. Restricting supply and continuing to make unrealistic offer prices into a market with little liquidity will have little impact until real and sustained demand returns.

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New Chinese invoices could lead to temporary rare earth glut

Rare earth magnets

Media reports out of China suggest the authorities there will introduce a new invoicing system for rare earths as early as this month and is yet another measure to gain control over a highly strategic resource, but in the short-term it could have some unintended consequences.

The new invoicing system is basically aimed at curbing illegal rare earth exports and some industry sources reckon it could lead to a sell-off of rare earths by small domestic traders and producers looking to quickly dump any material before the new measures come into force.

The invoicing system could be structured to be directly linked with individual company export and production quotas while also excluding smaller producers and traders, effectively putting them out of the rare earths business. Such an outcome would be in line with Chinese policy towards domestic rare earth producers, which has been to drive consolidation and therefore make the industry easier to control and regulate.

If a glut of rare earths does occur as a result of the new system, and if Inner Mongolia Baotou Steel Rare Earth Group, China’s largest rare earth producer, doesn’t step in to mop up the surplus material, then this could represent a brief opportunity for consumers to pick up material at relatively cheap prices.

Once those traders and producers are out of the market and their material bought-up, the Chinese grip on the rare earth market is likely to be felt even more keenly.  And the signs are that China wants to curb exports further and hence drive rare earth prices up.  Also, rare earth production outside China, especially for the heavier elements, is still a long way from filling the gap left by falling Chinese exports.

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Lynas rare earth output delay shows nothing can be taken for granted

The production of rare earths outside of China took a bit of a set-back with Australia-based rare earth producer Lynas announcing a delay with actual production now not taking place until the first half of 2012.

The announcement will not come as a surprise to many in the industry given the problems the company has had with its Advanced Materials Plant in Kuantan, Malaysia, which has been subject to intensive local protests.

Rare earth protests

Locals are worried about potential radiation levels from the plant and have mounted a highly vocal campaign against it, which has even spread to Australia.

The company told the Australia Associated Press earlier today that the set-back related to the final procurement packages tied to its construction and contractor delays that meant the refinery will only come on line during the first half of 2012. It had originally hoped to ship product by the first quarter of 2012.

Molycorp in the US, meanwhile, is bringing its production forward by three months, but there are industry sceptics who wonder whether this is achievable as well.

Rare earth projects are extremely capital and technology intensive relative to many other types of mining, take many years to bring online and due to their complexity can be subject to unforeseen problems that inevitably lead to delays.

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Solar rally in sight?

Solar power ready to flare

After the seemingly never ending discussions with participants in the minor metals industry about the stagnant markets and lack of business resulting in most metals prices drifting, it was a pleasant change to walk into the Solar Power UK 2011 Conference and Exhibition in Birmingham UK this week and feel an air of energy and optimism.

Although the solar market is having a difficult time at present, it is nevertheless an industry in its infancy with great potential for growth.  And with comments about improved business in October, it is hoped that this could be an indicator of a possible end of year rally.

Lower subsidies by government through the FiT programmes have resulted in slower demand in markets like Germany and the UK solar industry awaits the government decisions due in 2012 about future subsidy levels. The mass market has already been hit by lower tariffs and people speaking to Metal-Pages were fairly optimistic that the domestic tariffs would not be hit too hard. Also as one participant pointed out, the cost of solar panels is falling (one company mentioned a drop of 49%) which balances out the lower FiTs.

Bright lights for ICC

One point that came over very strongly in the presentation by Jeremy Leggatt of Solarcentury, the London company in charge of solar engineering and installation of the solar system on the roof of the new Blackfriars station in London, was the need for the industry to unite its voice coherently to the government in order to stand up again the major energy companies clubbing together to maintain the status quo.

German panel makers including Solarworld, Q-Cells SE and Conergy AG have been struggling to offset slower demand growth in their home market, which has lowered subsidies twice since June 2010. Phoenix Solar AG, a German solar developer, on Oct. 12 cut its full-year earnings outlook, saying it didn’t expect a year-end rally in Germany, which added a record 7,400 megawatts of panels in 2010 as sales surged in December.

Germany added about 1,610 megawatts of panels in the third quarter, according to Bloomberg calculations based on Bundesnetzagentur figures. That compares with 1,681 megawatts in the year-earlier period.
“These numbers signal that the market is picking up,” Henning Wicht, a solar analyst at researcher IHS Isuppli, said by phone from Munich. He had forecast 1,530 megawatts for the third quarter. “Developers and contractors tell me that October is very good, so there may be a year-end rally in store,” he said.

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