By now everybody, even those without interest in economics at all, will have heard of the commodities rally of the last months. Lack of confidence in the stock markets, in the health of bank's finances, the fear of a worldwide double-dip recession, currency wars, political near-conflicts around the globe... (more on these subjects on future posts) all have contributed to the price rise of most of the physical commodities, specially metals.
Traditionally the classic commodities have been precious metals like gold, silver, platinum and to a lesser extent, palladium. Not only they have an inherent value because of their relative scarcity, but they are also widely used in industry so they serve their wealth reserve purpose very well. Lately we have seen how "purely industrial" metals like copper, aluminum, titanium and molybdenum have joined the classics on this rally with quite interesting growths too. The good part is that all of the commodities named above are obtained from mines spread around the world, which helps to maintain a kind of equilibrium in their valuation.
This is not the case for rare-earth elements (see Wikipedia), as China is responsible for the 97% of today's rare-earth production. It does not take much to see why this is a problem when these elements are critical in industries like fiber-optics, wind turbines, home electronics (your iphone is included), hybrid cars, magnets in general... even night-vision goggles use them!
Because of their myriad of uses everybody considers rare-earth elements a strategic natural resource, and we know what happens if an individual country controls a strategic natural resource, it will be worse than oil. China is said to be reducing their export quotas a 35% (Bloomberg) for the beginning of 2011, which is expected to cause major struggles for the long list of manufacturers worldwide who use rare-earth metals. Prices will obviously skyrocket.
China could be taking this strategy even further by slashing totally their exports for 2012 onwards, keeping all the rare-earth production for themselves and creating an astronomically big bubble on the 3% they do not produce. This bold move will upset the US, Japan and Europe (probably in this order because of the size of their markets based on rare-earths), greatly affecting relationships between them and China and maybe (hoping to be wrong) putting them in the verge of war. We have already seen wars and long-time conflicts because of oil, so it would not be that strange if the same happened for rare-earth elements in the future due to the size of the industries involved.
It does not seem like China is worried about this outcome, as they are focused on their economic growth no matter what; but they should probably be... Internal demand is soaring in China but their main business is (and will be for a long time) exporting to the west. It is impossible for them to keep their economy growth rate without the US and Europe as clients.
Deflating the bubble
The only solution to avoid this coming bubble is ramping-up the extraction of rare-earth metals from mines on other parts of the world, maybe re-opening old mines that were closed due to environmental issues (more manageable with today's technology, but not green anyway) or low profit margins (clearly not the case anymore).
As prices rise one can also think of the business of recycling rare-earth metals from disposed cellphones, laptops, speakers, cars... the way it is done with batteries, gold in electronic circuits or lead. This would be a small part of the solution though, because demand is expected to keep rising and the recycling process would not be 100% effective in recovering the used materials.
But most of all, the solution will come from investing in the research of new deposits. We see with oil that as prices go up it becomes profitable to extract it from places that were un-thinkable before, the same applies to rare-earth elements. Problem is, it takes from 5 to 10 years to have a new rare-earth mine up and running, so we are already a little late for this.
Nobody knows how many years of supply are the Chinese rare-earth mines worth, so it becomes very difficult to make an educated guess about where will prices go, but anyway we can agree it will be a very profitable business sector in the future. The actual 3% rare-earth production that China does not control comes essentially from Australia, USA (California), Canada and South Africa; so unless a major deposit is found elsewhere these are the countries that can keep the sanity of the rare-earth market (while obviously profiting from it) and as a result of all the industries that depend on it.
We will suffer from the rare-earth bubble the same as we keep suffering from peak-oil, we just cannot live without either of them; but its effect can be partially contained if we start with the solutions right now.