This Could Send Rare Earth Metal Prices Skyrocketing

Lockheed Martin CorporationU.S.-China Tensions Could Put Bid Under Rare Earth Metals

In a world where tensions between Russia and the U.S. are even more intense than they were during the Cold War (with the exception of the Cuban Missile Crisis), the U.S. defense sector is justifiably worried about its military industry’s rare earths supply chain. Because the U.S. does not have a relevant rare earth industry, the Pentagon was forced to allow Lockheed Martin Corporation (NYSE:LMT) to use Chinese-sourced rare earth magnets.

The Pentagon has often advocated tighter regulations. China continues to supply over 90% of the neodymium and dysprosium needed to make the guidance systems fitted in drones, missiles, and new aircraft such as the F-35. Moreover, while Chinese producers are complaining about what they perceive as oversupply in the rare earths market now, as electric and hybrid cars become more popular, demand for these minerals in the longer term can only expand. (Source: “Lynas blames illegal China miners for weak rare earth prices,Reuters, Oct. 13, 2015.)

China has used the various tensions across its shores to increase its military budget. In 2014, it accounted for over 12% of gross domestic product (GDP), rising steadily in response to perceived territorial breaches in the South and East China seas. (Source: Richard A. Bitzinger, “China’s Double-Digit Defense Growth: What It Means for a Peaceful Rise,” Foreign Affairs, March 19, 2015.)  

China’s military budget has actually increased six-fold since 1992. U.S. allies feeling threatened by China’s military aspiration, from the Philippines to Japan to South Korea, have urged the United States to maintain a strong military presence in the area. China has conducted significant military exercises in 2013, modeling the destruction of the Japanese fleet in the East China Sea to recapture the Senkaku/Diaoyu islands.

China Evolving from Economic to Military Superpower

China sees itself as an economic superpower, expecting to surpass the United States in GDP by 2050, if not sooner. Like any economic superpower, China has also witnessed a rise in nationalism and it has intensified its military and geostrategic goals. The current geopolitical climate will raise tensions in the sourcing of critical resources like rare earths, while also prompting a corresponding need to maintain high levels of military preparedness in the U.S. to the benefit of the military industrial complex.

This means that Lockheed Martin Corporation, General Dynamics Corporation (NYSE:GD), Northrop Grumman Corporation (NYSE:NOC) and The Boeing Company (NYSE:BA) will be enjoying a long period of growth. Let’s not forget United Technologies Corporation (XETRA:UTC1.DE) or General Electric Company (NYSE:GE), given that those companies make the engines that power anything from fighter jets to heavy transports like the C5 SuperGalaxy and helicopters like the Apache.  

If more evidence was needed, the USAF plans to acquire new stealth bombers capable of flying undetected by the most sophisticated radar systems with the single goal of deterring a growing list of potential enemies. The Pentagon will soon announce which military contractor would be asked to develop a new stealth bomber in a multi-billion dollar contract. Even if this is on budget, it should easily surpass the value of the F-35 contract. (Source: David Axe, “A $550 million Air Force bomber so good it will never be used,” Reuters, Oct. 22, 2015.)

Lockheed Martin and Boeing to Build Next-Generation Bomber (NGB)

The last American bomber, the B-2, was developed over 30 years ago. The Pentagon is concerned that its current fleet of 160 bombers, made up by B-52, B-1 and B-2 aircraft, is largely outdated and vulnerable to new Russian and Chinese air defense systems. Therefore, it plans to order 100 new stealth bombers armed with state-of-the-art weapons and engines in order to fly great distances at high speeds and breach the most sophisticated defenses.

This does not mean that Washington is actually considering waging war on Russia and China. No, the goal is to deter any one of these powers from even engaging the United States. (Source: David Axe, “A $550 million Air Force bomber so good it will never be used,” Reuters, Oct. 22, 2015.). It is, in a sense, deterrence for liberty. The new fearsome aircraft will never have to drop a single bomb if it fulfils its geostrategic goals. This is a kind of nuclear weapon that’s necessary to have in order not to use.

Lockheed Martin stock and Boeing stock should be rising, as they are slated to get a joint contract. (Source: “Boeing and Lockheed Team for Air Force Long Range Bomber Bid,” USNI News, Oct 25, 2013.)

The U.S. Air Force has a great need for modernization, which causes defense stocks such as Lockheed and Boeing to have a very long shelf life. The USAF first called for new bombers in 2004 with the goal to replace obsolete aircraft by 2018. Nevertheless, in 2010, then-Defense Secretary Robert Gates suspended the program, noting the U.S.’ tendency to develop overly complex and overly expensive combat aircraft.

However, in 2011, the Pentagon authorized the USAF to proceed with developing a new bomber with the premise that each aircraft should not cost more than $550 million. The new bomber should enter service by the mid-2020s.

Meanwhile, China’s aerospace and shipbuilding companies listed in Shanghai rallied today in response to a surge in U.S.-Chinese tensions following a U.S. navy warship’s breach of Chinese territorial waters in the South China Sea. Aerosun Corp., which makes parts for the civilian aviation industry, and Aerospace Communications Holdings Group Co. both jolted 10 percent, as did other Chinese industrials in Shanghai.

According to Chinese authorities, a U.S. warship, the guided-missile destroyer USS Lassen, was closer than 12 miles to a group of artificial islands belonging to China in the South China Sea. The breach of territorial waters has sparked furious condemnation from Chinese authorities, who accused the United States of having threatened China’s sovereignty.

USS Lassen Incident in South China Sea Illustrates Rising Chinese Military Confidence

The USS Lassen sailed in the waters surrounding at least one of the so-called Spratly islands, which the Chinese refer to as the Nansha. China’s reaction was swift and harsh, warning the U.S. Navy not to interfere in the Spartlys, noting that in the future China would adopt all necessary measures to protect itself from what it considers a violation of its territorial waters. Washington has rejected the claim in the name of freedom of navigation and free trade.

China has demanded for the U.S. to refrain from “provocative and risky actions,” while the Pentagon confirmed that the USS Lassen did sail less than 12 nautical miles from the coast of the disputed islands, the international limit for territorial waters. (Source: Ben Blanchard and Andrea Shalal, “Angry China shadows U.S. warship near man-made islands,” Oct. 27, 2015.)

Such breaches, especially in the case of China, can have significant effects on the prices of strategic commodities-materials that are necessary for national security. China is also at odds with other Asian neighbors, triggered by spats over territorial control in the South China Sea. In the latter case, the triggers are both natural resources in the disputed sea areas and the control of important waterways.

The South China Sea is becoming at least as tense as the East China Sea, which is always at risk of an eruption of a Japanese-Chinese crisis over the Senkaku/Diaoyu islands. Japan formally annexed the territory in 2012, but China has not recognized this step, refusing to compromise.  In 2013, China responded to Japan and the United States delineating an air defense zone in the East China Sea. All non-Chinese passenger and military aircraft must identify themselves and follow the instructions of the Chinese Air Force when flying over the area.

In the context of economics and trade, geopolitical tensions in this part of the world are significant. No doubt, the latest spat will have the U.S. Defense department concerned over the sourcing of rare earths. These special elements, noted for their highly magnetic properties, are essential to the manufacturing of anything from cell phones to missile guidance systems.

A Pentagon investigation found that Lockheed Martin used too many ‘made-in-China’ components for the F-35, the latest generation fighter jet, and the centerpiece of the U.S. Air Force. Indeed, there are plenty of Chinese-made components in the B1 bomber and F-16 fighters. The components include both manufactured ones and raw materials, often using rare earth metals, which are abundantly mined and processed in China but are truly rare in the West.

For self-evident security reasons, the Pentagon would prefer U.S. military equipment to be made using exclusively American made parts. Where this is not possible, the parts should be sourced from a NATO ally. U.S. law actually bans this practice when the foreign supplier is China or any other country that is not considered an ally. This is because reliance on a foreign supplier makes the United States more vulnerable in a conflict situation.

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