What Happened to the Rare Earth Metal ETF?


"Rare earths will not disappear anytime soon, and current valuations warrant a closer look at a sector that still has the potential for an extremely robust future."

Commodity investing has had a rocky road over the course of 2012 as many products have seen divergent returns in the space. Some, such as corn and many of the other grains, have seen solid performances while other natural resources have been under significant pressure in year-to-date terms.

One such commodity segment that has had a 2012 to forget is undoubtedly the rare earth metal space. These metals include key products such as cerium, neodymium, and Ytterbium, which are vital components in a number of high tech applications around the world (see Rare Earth Metal ETF Jumps on WTO Tensions).

The year started off promising enough for the space, as worries over a brewing supply shortage and a rebounding economy helped to send prices for many of these key products much higher. In fact, several countries squared-off against China at the WTO over the country's rare earth export restrictions (See Could This Be the Year for These Mining ETFs?).

The current rare earth metal king, China, controls about 90% of the market and has repeatedly threatened to close off even more supplies to the outside world have riled the supply/demand balance for years. Thanks to this overhang, many remain incredibly bullish on rare earth metal producers, and this was evidenced by a strong performance in the space to start 2012.

However, this did not last, especially when looking at the top ETF option in the rare earth metal world, the Market Vectors Rare Earth/Strategic Metal ETF (REMX).This product, which tracks a group of companies that are engaged in some aspect of the mining process for these metals, started the year up 23% in the first month but thanks to a horrendous six month period, is now sporting a year-to-date loss of nearly 15%.

What Happened

Basically, the global slowdown has been absolutely devastating on the ‘high beta' mining segment of rare earth metals. Demand for a number of products that are big users of rare earths—such as consumer electronics, clean energy, and defense applications—have seen their demand levels or outlooks fall apart in the past few months.

Furthermore, according to mineralprices.com, only one of their followed rare earths is actually in the green on the year from a performance perspective. Instead, most have fallen by more than 17%, including four that have witnessed losses exceeding 40% from a one year look (also see The Comprehensive Guide to Gold ETF Investing).

In addition to the global slowdown, broad speculation of a rare earth bubble being popped is also running through the market as well. "We had a bubble last year—an anomalous speculative blip—that ran REE prices to the sky. It happened just as the junior miners were coming into full bloom" said Jack Lifton of Technology Metals Research. "At that time, I would say most of the junior REE exploration companies were overvaluing their projects something fierce. Then the market herd jumped in and ran the prices way up."

Lifton also noted that of the 260 U.S. listed rare earth mining firms, only one, Molycorp (MCP - Snapshot Report) is actually at production stage. MCP isn't exactly having a great year either, as the stock is down almost 60% year-to-date, and is trading close to its 52 week lows putting the stock down 80% over the past one year (also see Time to Exit the South Africa ETF?).

Given this terrible performance from one of the American market leaders, the situation could be pretty bad in the coming months for those firms that are in the space, but haven't yet produced anything. This could be especially true if rare earth metal prices stay depressed, making it unprofitable for many of these exploration firms to bring their mines online, potentially casting a gloomy tone over the entire market space.

Yet with all the doom and worries over the space, the fact remains that rare earth metals are crucial to modern life. These products are in everything from flat screen TVs and steel alloys, to jet engines and hybrid cars, and in many cases, their replacement by other minerals or substances is incredibly expensive, impractical, or downright impossible.

Given this reality, a closer look at the aforementioned REMX could be in order. The product offers broad exposure across the rare earth metal industry, focusing in on various mid cap and small cap producers (read Has The Junior Gold Mining ETF Lost Its Luster?).

Furthermore, the fund is pretty well diversified from a country perspective, putting no more than 25% of assets in any one country, and instead allocating at least 5% to nine different nations. The ETF is also well spread out from an individual security perspective as no one company accounts for more than 7.5% while all of the top ten make up at least 5% of assets.

Still, make no mistake about it, REMX has had a terrible run over the past year, slumping by nearly 40% in the time period. However, this could finally be making this important market segment a decent choice for those with extremely long time horizons and a stomach for volatility.

Rare earths will not disappear any time soon, and since many valuations are now reasonable in the space, it could be time to take a closer look at REMX for a new way to play commodity mining that has the potential for an extremely robust future. The fund could offer a more diversified way to target rare earths while doing so at a reasonable cost and with tight bid ask spreads as well.

Eric Dutram
Zacks Investment Research

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