China is hoarding its most vital export – here's how to profit

China is best known in economic circles for its dependence on exports. It's often seen as the country's Achilles heel.

But there's one particular export that China is increasingly keen to keep within its borders. And the move could make life rather uncomfortable for high-tech manufacturers elsewhere in the world.

It's a group of raw materials that are absolutely vital to most of the world's remaining growth industries, from 'green' technology to smart phones.

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They're called rare earth metals and they could be about to get rarer...

Why it matters that China is cutting rare earth exports

Over the summer, China cut export quotas for rare earth elements by 72% for the second half of this year.

Why does this matter? For the two usual reasons demand and supply. On the demand side, these metals are important components in all the high-tech industries that we hope will drive the next phase of global economic growth.

Everything from energy efficiency to playing with your latest iGadget depends on rare earth elements. One metal called terbium can cut electricity usage in lighting by up to 80%. Other rare earths reduce the weight of magnets in electric motors, making them crucial to better wind turbine manufacture, for example. Still others are used in applications from petrol refining to touch-screen displays.

And on the supply side, China not only has the world's largest reserves of rare earths, but it also accounts for almost all of the world's current production. The country's leaders are well aware of the strategic importance of these assets. Indeed, as far back as 1992, China's leader, Deng Xiaoping, said that "the Middle East has its oil, China has rare earth".

China wants to produce higher value goods in its manufacturing industry, as my colleague Cris Sholto Heaton has regularly noted in his MoneyWeek Asia email (if you don't already get it, sign up here it's free). That means it wants to keep more of its supply of rare earths to itself. After all, if you control the supply of the raw materials needed to drive an industry, then that gives you a great deal of power in determining the shape of that industry.

To be fair to China, rare earth extraction is also extremely environmentally unfriendly, even by mining standards. As The Economist puts it, extraction involves using "highly toxic chemicals. Horror stories abound about poisoned water supplies and miners". And it's the environmental concerns that China is using to justify the crackdown on exports.

What this means for the rest of the world

But what does it mean for the rest of us? Well, the price of rare earths has shot up. And no wonder. The cut in exports means that China is now exporting less than the rest of the world consumes each year.

Now this isn't necessarily the great disaster story that some are making it out to be. Despite the name, there's plenty of potential supply of rare earths elsewhere in the world. We're not at 'Peak Rare Earths' yet.

As Reinhard Butikofer, a German MEP, wrote in the Wall Street Journal the other day, "several countries have considerable reserves of rare earths. Had it not been so easy in the past to import them from China, we would have focused on these alternatives."

But of course, this takes time and effort. The Economist cites mining website Kaiser Bottom-Fish Online: "The problem of supply is easily solved. It just takes three to five years and billions of dollars." And if China a country not known for its overweening health and safety regulations is squeamish about environmental side effects of rare earth mining, imagine how hard it will be to get mines going elsewhere in the world. Indeed, one of the many projects that non-Chinese producers are trying to get back into production is a mine in California that was shut down in 2002 over environmental concerns.

How investors can profit

As is standard with commodities, rising prices are encouraging more supply and will also make people find cheaper substitute materials. But in the meantime, investing in rare earths looks like a good way to profit from the ongoing growth in high-tech industries.

My colleague Eoin Gleeson has been following the rare earths story for a few years now. Indeed, he recommended MoneyWeek readers buy into Australian rare earth miner Lynas Corp shortly before the Chinese government attempted to buy it last year. He gave us his latest take on the stock a few weeks ago, plus news of another early-stage rare earths project for brave investors. You can read the piece, including his latest tip, here: Join the rush for rare earth metals (If you're not already a subscriber, subscribe to MoneyWeek magazine.)

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