REMX: Downgrading Strategic Rare Earth Metals ETF On China Risks (NYSEARCA:REMX)

Last May, I initiated coverage of the VanEck Rare/Strategic Metals ETF (REMX) with a BUY recommendation based on bullish demand for rare Earth metals combined with the fund’s recent out-performance. However, since that time, REMX has significantly under-performed the S&P500 (see below) and the tension between the U.S. and China has been ratcheted up – most recently due to “balloon drama” and the cancellation of U.S. Secretary of State Tony Blinken’s trip to China, which was supposed to put some guardrails on the bi-lateral relationship and lower tension. As a result, today I am downgrading REMX from BUY to outright SELL.

As can be seen in the graphic above, investing in a similar theme (albeit primarily in copper – i.e. not “rare earth” centric) via Freeport McMoRan (FCX), has been a much more profitable trade for investors.

Investment Thesis

Seventeen rare-earth elements – including neodymium, praseodymium, dysprosium, terbium, and yttrium – are critical to the manufacture of strategically important devices like permanent magnets. These magnets are critical components in strategic applications like leading-edge military and civilian aircraft, industrial motors, and generators. Rare-Earths are also required and critical to many other fast-growing markets such as hybrid and electric vehicles (EVs), wind turbines, and solar panels. These metals are also critical for national defense applications including guidance systems, lasers, and radar and sonar systems.

However, the vast majority of rare-earth magnets, alloys, and catalysts come from China – which also has a near global monopoly in rare-earth-enabled component manufacturing. Indeed, as of year-end 2021 data, Mining-Technology.com reports that China controls over 60% of the global production in rare-earth metals:

This state of affairs has not gone unnoticed by President Biden and, in February of last year, Biden announced an initiative for Securing A Made-in-America Supply Chain For Critical Materials. That followed a Presidential executive order in 2020 (Executive Order 14017, America’s Supply Chains) after the Biden Administration released the United States’ first full strategic supply chain assessment which clearly showed America’s over-reliance on foreign and adversarial nations for rare-earth metals. The conclusion reached in that report was that this reliance for rare-earth metals posed a clear and present threat to the United States’ economic and national security.

With that as background, let’s take a closer look at how the VanEck Rare/Strategic Metals ETF has positioned investors for success going forward.

Top-10 Holdings

As of the end of January, the top-10 holdings in the REMX ETF are shown below and equate to 58.6% of the entire 24 company portfolio:

My first observation is that China-based companies equate to 4 of the top-10 holdings with an aggregate weight of 24% of the entire portfolio. Indeed, behind U.S. ally Australia (a 40% weight), China is the second largest foreign exposure in the fund with 30.6% of net assets and 2x that of the investments in U.S.-based companies:

The #1 holding in REMX is Australia-based Pilbara Materials (OTCPK:PILBF) with a 7.9% weight. Pilbara holds a 100% interest in the Pilgangoora lithium-tantalum project located in Western Australia. The stock is up 35% over the past 12-months and trades with a forward P/E=26x. With such a large percentage of the fund invested in Pilbara, the REMX ETF is betting big on the lithium/EV battery thesis.

Lynas Rare Earths (OTCPK:LYSCF), another Australian-based company, is the #4 holding with a 6.3% weight. Lynas produces rare-earths including yttrium, lanthanum, cerium, praseodymium, neodymium, promethium, samarium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, ytterbium, and lutetium – primarily as a result of the company’s interest in the Mount Weld project in Western Australia. Yet Lynas is down 10.5% over the past year and trades with a forward P/E of only 15.5%.

U.S.-based Livent Corp. (LTHM) is #6 holding with a 5.2% weight. Livent sells performance lithium compounds primarily used in lithium-based batteries. These include battery-grade lithium hydroxide for use in high performance lithium-ion batteries. Since the 2020 lows, Livent has ridden the fast-growing EV transition to excellent revenue and earnings growth:

Livent stock is roughly flat over the past year and currently trades with a forward P/E of 18x.

The top-10 holdings are rounded out by Canada-based Lithium Americas Corp (LAC). LAC explores for lithium deposits and owns interests in the Cauchari-Olaroz and Pastos Grandes projects in Argentina as well as the Thacker Pass project located in north-western Nevada. To date, the company is unprofitable, has very little revenue, and sports a $3.5 billion market-cap. Yet Seeking Alpha contributor Sunrise Analysis has a STRONG BUY on LAC.

Performance

The long-term performance of the REMX ETF is, in a word, terrible:

That said, the recent and excellent 3-year average annual performance (38.7%) is notable. The question is: are the risks of investing in China worth the potential (and relatively recent …) rewards? Meantime, REMX charges investors a 0.53% expense fee.

Risks

The companies in the REMX ETF are not immune to the current general risks and headwinds the global economy faces: high inflation, relatively high energy costs, rising interest rates, and continued impact of the global pandemic on supply-chains, labor, and markets. Miners also use a lot of diesel fuel, and diesel is not only tied to global oil prices, but there is also a very tight supply of global diesel refining capacity. That said, supply of rare-earths are so strong that miners would likely be able to pass higher energy costs directly to buyers.

However, in my opinion the largest risk facing the REMX ETF is its large weighting in China. Although the ETF’s 30.6% exposure to China is about half that of China’s 60% share of global rare-earth production, it is obviously still a significant portion of the fund’s assets. As we have seen in the past, President Xi can make a sweeping change in export policy with the wave of his hand.

After all, dictators can do that. I pointed out the same risk with the VanEck Russia ETF (RSX) in my September 2021 Seeking Alpha article RSX: Commodity Heavy Russia ETF Is A High-Risk And Low-Reward Proposition. The RSX ETF is down 81% since that article was published due to Putin’s horrific war-of-choice on Ukraine, Russia’s weaponization of energy supplies to the EU, and the resulting sanctions placed on Russia by the U.S. and its Democratic & NATO allies. The RSX ETF has been “frozen” for nearly a year and VanEck is trying to figure out how to sell the Russian assets, distribute whatever proceeds it can get, and to liquidate the fund. It’s not hard to imagine a similar scenario for the China-based companies in the REMX ETF. After all, China and Russia have a strategic partnership which, it would appear, is generally designed to be a united front against the United States and the free-and-Democratic West.

Summary & Conclusion

There is no doubt that there is a strong investment thesis supporting the rare-earth and strategic metals complex due to the global clean-energy, EV, and battery backup transition. However, investors would likely be better off making some key investments in individual companies based in countries that are allies of – or at least friendly to – the United States.

Bottom line: The REMX simply has too much exposure to China for my tastes. REMX is a SELL.

For additional perspective, I’ll end with a 10-year total returns comparison of the of REMX ETF versus the Vanguard S&P 500 ETF (VOO) and copper/moly/gold producer Freeport-McMoRan:

As can be seen in the graphic above, REMX has been a severe laggard over the past decade. I doubt the next decade will be much different.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.