In light of this recent weakness for many rare earth metals, China has decided to more or less keep the rare-earth export quota constant for the new year, hoping that flat supply will boost prices once again for the sector. This could especially be true given that China currently dominates the market, making up nearly 90% of the total global supply. Yet, unfortunately for the sector, the weakness in the economy is really beginning to hurt end users of the metals, pushing them to really cut down on the use of these ultrahigh cost products. "The quota has become pointless if export demand falls short of the limits," said Wei Chishan, a Shanghai-based analyst at SMM Information & Technology Co., a data provider. "Rare-earth users are under great pressure to pass on surging costs, while the global slowdown has slashed demand." (read Is USCI The Best Commodity ETF?)
With these pressures and the general push away from commodity-focused investments in the last few months, investors in the main ETF tracking the sector, the Market Vectors Rare Earth/Strategic Metals ETF (REMX) have seen huge losses. The product is trending toward a 52-week low and has fallen by 36% over the course of 2011, including a nearly 41% loss in the past six months alone. Yet, while 2011 has been disastrous for REMX, there is still some hope that 2012 will produce far better returns for those invested in the sector (also read Can You Fight Inflation with this Real Return ETF?).
That is because while demand is slack right now, the incredible importance of the materials in this space and their wide range of applications ensures that they will always see a decent level of buying. Rare earths are used in everything, including jet engines, hybrid technologies, flat screen TVs and a host of other applications, meaning that weakness in any one sector is unlikely to scar the industry too badly. Furthermore, as Japan continues to rebound, its use of rare earths—especially if it tilts towards clean energy—could surge, putting upward pressure on prices going forward (see Three Best Gold ETFs).
Add in the fact that China thoroughly dominates the supply of these crucial products and that no further meaningful supplies can come online quickly, and one can easily argue that the slump in rare earths is more about confidence than fundamentals. For investors seeking to make a play on this beaten-down sector in hopes that 2012 will be far better for the industry, a closer look at the Market Vectors Rare Earth Strategic Metal ETF (REMX) is needed.
Rare Earth Metal ETF in Focus
For investors seeking to make a play on the sector, REMX is truly one of the only choices available in the space. The fund tracks Market Vectors Rare Earth/Strategic Metals Index, which is a rules-based, modified capitalization-weighted, float-adjusted benchmark intended to give investors a means of tracking the overall performance of publicly traded companies primarily engaged in a variety of activities that are related to the mining, refining and manufacturing of rare earth/strategic metals. Currently, the product charges investors 0.57% a year in fees and has close to $210M in AUM, suggesting that the product is in line with others in the category for expenses and that the fund has attracted a decent amount of interest from investors (read Time to Consider the Silver Miners ETF).
In total, REMX holds 27 securities, putting just about 60% of assets into the top 10 holdings, with high weightings going toward Iluka Resources, Lynas Corp, and Titanium Metals (TIE). The fund has a definite tilt towards small- and mid-cap securities, as just 7.7% of assets go toward equities that have a market cap above $5B. The Van Eck fund also has heavy exposure to international and especially developing markets, suggesting that it is already prone to heavy bouts of volatility in short time frames.
Undoubtedly, REMX can experience another huge slump in 2012, especially if the economy remains weak and investors continue to shun commodity-focused assets. Yet, given the strong underlying fundamentals of the industry, and the importance of rare earths to virtually every sector of the high tech economy, there is a pretty strong chance that this rare earth metal ETF could see a solid period of trading going forward. As a result, a small allocation to the space could be warranted by investors who have a high-risk tolerance and believe in the strength of these products over the long term, despite short-term pressures.
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Eric Dutram, Zacks Investment Research