Imagine your world without TVs, cell phones, laptop computers, MRIs and CATscans, lasers, advanced aircraft materials, guided missiles and Ipods, among other things.
These products need Rare Earth Elements (REE) to produce, a group of 17 elements that most people have never heard of.
In 1992, Deng Xiaoping, then ruler of China, said: "There is oil in the Middle East; there is rare earth in China." In 2005, China produced 95% of the world's supply of REEs.
Visiting the rare earth rich Baotou region of China, Chinese President Jiang Zemin said: "Improve the development and applications of rare earth, and change the resource advantage into economic superiority."
In its July report to Congress, the U.S.-China Economic and Security Review Commission said that from the early 1990s Beijing had embarked on a "detailed strategy to control the rare-earth market."
In 1994, China provided 46% of global supply. In 2005, it provided 95%.
China has provided an abundant supply of REEs, driving other world mines out of business, such as the only US mine, Mountain Pass. Over the last decade, China, which has major deposits of rare earths, has invested heavily in new mines and processing plants as part of its plan to dominate the industry. It has also made some critical foreign investments to secure important processing and manufacturing technology and has financed the world's biggest network of rare-earth research and development laboratories.
China has now introduced export quotas for its domestic producers in a bid to control supply and prop up prices.
Currently the US imports 100% of its rare earth resources (95% from China) and has no stockpile.
Adam Hamilton at Zeal analyses the sharp decline in the Commodities Research Bureau (CRB) Index in his essay, Breakdown. I summarise his essay below:
After five years as one of the best-performing market sectors, commodities such as metals and energy have spiraled sharply downwards in the last few months. The CRB index has fallen from 365 in April to under 300 recently.
The rise of Asia and its huge new demand for commodities to build infrastructure coupled with restrained and inelastic supplies is the perfect recipe for many years of prices rising on balance. But fast and ugly losses are challenging the faith of even some long-time commodities bulls.
Adam asks the question: is the bull market in commodities over?
And if not, then why has the plunge in the CRB Index been so severe, deeply violating the technical support provided by the 200 Moving Average (the black line in the chart below)?
The answer appears to lie in how the CRB index is calculated. Started in 1957, its 10th revision took place in July 2005.
As Adam puts it "The pre-July-2005 smoothed line looks relaxed and gradual, a very conservative and measured bull market. The post-July-2005 looks like an electrocardiogram of a trader on speed, frantically volatile. These two blue tracings don't even look like the same index!"
The major change: Today's CRB index is no longer geometrically averaged nor is it equally weighted.
"Previously all 17 component commodities were each responsible for about 5.9% of the index's weight. This also contributed to the CRB's traditional low volatility. For example, gold could rise 50% but if the other 16 components were flat the CRB would only be up a few percent at best. While it made the CRB smooth, this wasn't particularly realistic. At the time crude oil was weighted the same 5.9% as orange juice. Are oil and orange juice equally important in our global economy today?"
Oil now represents 23% of the index, up from 5.9%. So, when oil prices fell sharply, it dragged down the CRB Index far more than it could have done before July 2005.
Oil was falling, forcing the CRB to fall in sympathy. But as the CRB spiraled lower and spooked traders, they sold off other commodities like the metals which caused the CRB to fall even further. Oil lit the fire of this plunge and the CRB's flagship status among professionals fanned it.
So, where does this leave investors?
Adam has this chart which shows the CRB Index adjusted for inflation.
The blue line is the nominal CRB Index and the red line is the CRB Index adjusted for inflation. In real terms, the CRB Index has a long way still to rise to reach new highs.
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