Ramaco Resources Initiated at Equal-Weight by Morgan Stanley

Al Root

The domestic rare-earth industry has gone from zero to hero in the blink of an eye this year, as the U.S. suddenly realized that ceding a small upstream commodity industry to China threatened America's ability to make everything from cars to drones to AI-trained robots.

Understanding just how China came to monopolize the rare-earth industry can help investors anticipate what's coming next, making it easier to invest in the critical — and exceedingly volatile — sector.

"While China's industry is highly skilled and highly capable, its dominant position is both enabled and hardened by subsidies, price manipulation, and scale," said Matthew Sloustcher, MP Materials' executive vice president of corporate affairs, in testimony to the House Select Committee on China earlier this week.

"In the early years of our business, we produced mineral concentrate at Mountain Pass [mine in California] that could only be sold into China, the sole market with the refining capacity to process it."

MP, of course, didn't want to sell intermediate products to China forever, so it reinvested its revenue into refining capabilities. It was an untenable strategy amid Chinese dominance, however.

"But as we prepared to launch, neodymium-praseodymium prices, [a] key commodity, collapsed to levels below even China's lowest production costs," explained Sloustcher. "That predatory pricing destroyed incentives to invest, and it kept capital scarce."

It's a textbook strategy to grow market share and keep competitors out: Drive prices lower, so other players can't build up their own business. It worked spectacularly. In 1985, the U.S. mined almost half of the world's rare-earth minerals, while China mined 0%. By 2010, China mined 70% and the U.S. mined 0%. China also came to dominate refining, with an estimated 85% of global capacity.

The shifting industry structure didn't go unnoticed. The Defense Department has worked for the better part of a decade to reduce dependence on potential foreign adversaries. It took a huge step in July, announcing a deal with MP that included an equity stake, a price floor for rare-earth materials, and a guaranteed customer for the rare-earth magnet capacity that MP is building.

"In a short period of time, we'll have everything we need for ourselves, " President Donald Trump told 60 Minutes in early November.

Still, it will take a while for China's influence to diminish. Beijing's October threats to restrict rare-earth exports — a position it later backed off from — injected more volatility into the sector.

Coming into Friday trading, MP stock was down 24% over the past month. Shares of aspiring rare-earth miners USA Rare Earth and Ramaco Resources were down an incredible 54% and 60%, respectively.

Volatility takes its own toll: It is synonymous with risk for investors. Higher-risk investments require higher returns, raising the cost of capital for anyone looking to start a new business.

Recent trading is a warning that the U.S. shouldn't declare victory in the rare-earth war just yet.

"Where appropriate, the federal government should deploy tools that neutralize predatory pricing," while easing access to project permits and working with allies, added Sloustcher. "Finally, the United States should incentivize and reward American companies that source U.S.-produced critical minerals and derivative products."

MP and other rare-earth producers need domestic customers, too. China isn't only the largest producer, it's the largest customer for rare-earth products, which end up in everything from iPhones to electric vehicles to fighter jets.

China might have overplayed its hand. The U.S. is intent on building a domestic rare-earth supply chain, and companies including Apple and General Motors have made deals to secure a domestic supply of such minerals.

A lot of stakeholders have an interest in the success of the domestic rare-earth industry. It's one reason that, despite recent declines, MP shares were still up 263% year to date through Thursday trading.

MP shares were up 0.6% in early trading on Friday at $57, while the S&P 500 and Dow Jones Industrial Average were up about 0.5%. Ramaco shares were down 0.7%. USA Rare Earth stock was off 0.3%.

Write to Al Root at allen.root@dowjones.com

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