REMX: Bullish Tailwinds May Continue To Fuel Rare Earth Rally
Feb. 13, 2021 5:01 AM ETVanEck Vectors Rare Earth/Strategic Metals ETF (REMX)5 Comments10 Likes
Rare-earth and strategic metals have risen over the past few months due to a developing shortage.
Last year saw a slight decline in the production of rare-earth metals due to COVID as well as increased demand due to the electric vehicle boom.
The rare earth miner ETF REMX has doubled in value in recent months and may still rise higher due to its relatively low valuation.
REMX has considerable exposure to China which creates geopolitical and monetary risks.
Rare-earth miners are a riskier and more speculative bet, but this rally has legs.
The past few months have seen extreme action across the financial market. There has been a boom in clean energy stocks as well as the commodity market. Specifically, the rare-earth commodity market. This rally is tied to clean energy due to the fact that rare earth metals are a key component in solar and batteries. Additionally, there has been a shortage of rare earth metals due in part to the fact that most come from China.
Since November, the VanEck Rare Earth ETF (REMX) has more than doubled in value. I covered the fund toward the end of 2019 in "REMX: Stability Returning To Strategic Metals" and gave the ETF a bullish outlook based on what appeared to be growing geopolitical tension and risks. The fund has risen 120% since the article was published. Before then, most rare earth commodities were in a significant glut which caused low prices and negative cash flow for most miners. Today, the story is far more bullish.
Battery metals such as lithium and cobalt have seen among the strongest recent performance. See below:
The performance of these two key electric-vehicle metals is reflected in most of the other rare-earth metals including molybdenum, neodymium, rhodium, and manganese.
The boom has been a saving grace for REMX which was at high risk of fund closure when I covered it last due to years of abysmal returns. The fund has seen its AUM skyrocket and its price has returned to 2018 peak levels. See below:
ChartData by YCharts
Importantly, most rare-earths are still a bit below peak 2018 levels. Lithium was just above 150K CNY/T at its 2018 peak and trading at just below half that value today. The same is true for most of the other strategic metals. The breakout is a great sign, but there are a few key risks in the market that REMX should have in mind.
How High Can Rare Earths Rise?
Unlike most industrial and precious metals, strategic earth metals are extremely rare. While this is obvious given their name, it is important because rare earth metals can rise to extreme levels in a shortage. Such is the case for rhodium (used in catalytic converters ) which has risen by around 400% over the past three years.
The recent boom in rare earth prices is due to increased demand for electric vehicles and similar items that are rare earth intensive. Additionally, around 85-90% of these metals come from China, so the COVID shock last year created disruptions that exacerbated the current supply-demand imbalance. Obviously, the strategic and rare earth metal markets are much more opaque so it is difficult to estimate the shortage today, but in the recent past, China has flirted with cutting rare earth exports in order to harm the U.S economy. If the situation surrounding Taiwan continues to escalate, then it is possible this threat returns.
While the recent rally has been nothing short of spectacular, strategic and rare earth metal prices are still depressed today. Most are trading well below their long-term highs which occurred during the 2010-2012 metal bull market and/or the 2016-2018 bull market. Put simply, they could have a long way to go higher. Particularly if demand for green technologies continues to rise.
For the time being, it seems very likely that the shortage grows. However, if there is a large economic decline that causes consumer and commercial spending on such items to decline, then the bull market could end. This is a risk to keep in mind considering the global economy remains in a precarious position today. That said, the fundamental outlook for rare earth and strategic metals prices remains bullish.
A Look at REMX's Holdings and Value
It is important to keep in mind that about half of REMX's holdings are located in China and only 10% are in the U.S. A rise in geopolitical tensions may be bullish for the metals, but it could be deadly for the mining stocks in the fund. Even more, REMX carries a 42% exposure to the Chinese yuan which has risen over the past few months and I believe may reverse since the liquidity shortage will likely be cleared. Again, this gives REMX possible negative exposure to geopolitical tensions even though metal prices may have positive exposure.
The companies in REMX are exposed to a wide variety of metals. Most notably, cobalt, molybdenum, lithium, tungsten, and titanium. Demand for these metals is strong, particularly considering clean energy vehicles (including both electric and catalytic converters) are expected to see much higher demand over the coming decade.
Despite the gains, most of the companies in REMX are not overvalued. The fund has a weighted-average "P/E" of about 20X which is not high. Its forward earnings will likely be considerably above TTM earnings due to the recent rise in rare earth metal prices, so its valuation is quite low. Still, "normal" valuations in China are far below that of the U.S. The Large-Cap China ETF (FXI) has a "P/E" of 17X while the S&P 500's is above 30X.
Despite its tremendous rise, I still believe that REMX is undervalued. Its price-to-earnings is on the lower end of the spectrum considering miner earnings will likely rise significantly over the coming quarters given metal prices today. If rare earth and strategic metal prices rise even further, which I believe is likely, then the fund is very inexpensive.
The Bottom Line
Overall, REMX seems to be both a value and growth opportunity. The outlook for rare earth metals is strong and the companies in the ETF are potentially undervalued. Quite frankly, I would not be surprised to see the ETF rise over the $100 level and possibly onward to $130-$160. This would give it a weighted-average "P/E" of 31-38X, obviously, a high valuation but fair given the outlook for the commodity market.
Now, there are very important risks to consider which may upend my bullish outlook. First, there is an effort to increase the production of rare earth metals outside of China in order to reduce dependence. This could flood the market with new material and cause supply to outstrip demand. Second, demand for these metals could be hampered by the weak global economy as consumers and businesses look to reduce large spending. Third, the most profitable and cheapest of the companies in REMX are situated in China. This creates geopolitical risks that could cause a decline in sales or currency volatility which harms REMX. In my opinion, this is one of the most important risks to consider in the face of today's immense geopolitical uncertainty.
While I remain bullish, I will change this view quickly if the fundamentals shift. I am also less bullish than in the past when the setup was extremely strong. The recent rally was also very extreme and it is likely REMX will face difficulty breaking over the $100 resistance level set in 2018. Due to its risk, position sizing should be limited, but I believe that REMX will likely continue to be a strong trade backed by many tailwinds. For now, I'll be looking to buy on a pullback, ideally under $75.