Recent reports have shed light on a pivotal development in the global rare earth market: the Kachin Independence Army in Myanmar has reportedly taken control of the country’s rare earth mining regionsThis shift has led to a significant disruption in local mining activities, compounded further by the closure of borders due to the ongoing political turmoil in MyanmarNotably, in 2023, Myanmar contributed around 11% of the global rare earth production, predominantly focused on medium to heavy rare earth ions, marking it as a significant player in the rare earth industry and thereby impacting global supply chains considerably.

This disruption occurs in a climate already troubled by rising trade protectionism worldwide, particularly directed towards China, which accounts for over 40% of global rare earth output

This combination of local instability and increased international protectionist policies could tighten the supply of these crucial materials even further, heightening the urgency for global markets.

Over the past three years, the prices of rare earth elements have been in a steady decline, with 2023 witnessing industry-wide inventory levels plummeting to a five-year lowInvestors have faced considerable losses due to this price downturnHowever, financial analysts are hopeful that the conflict in Myanmar coupled with rising trade protectionism could act as catalysts for a rebound in rare earth prices, thus potentially revitalizing the fundamental aspects of this industry

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In November, Northern Rare Earth announced a modest increase in the prices of multiple rare earth products, signaling a potential shift in market dynamics.

In light of this news, the rare earth sector in Hong Kong and A-shares has experienced some fluctuationsFor instance, Jinli Permanent Magnet, listed as 06680 on the Hong Kong Stock Exchange, saw a striking 44% increase on November 1 following the announcement regarding Myanmar's rare earth lockdown, followed by a period of volatility as investors took profits

Larger funds have shown notable retention within the sector, indicating a keen interest from institutional investors.

Turning Point for the Rare Earth Industry

Rare earth elements are vital as strategic resources for many nations, with applications spanning the military, permanent magnets, electric vehicles, robotics, and beyond

China has claimed the position of the world’s primary provider of rare earth resources, which is highlighted in a report by Haitong SecuritiesBy 2023, global reserves of rare earths reached approximately 110 million tons, with China holding a staggering 46% share of total reserves and 68% of global production, reinforcing its dominant status.

Several countries hold significant rare earth reserves, including Vietnam, Russia, India, and Australia, collectively holding 91.8% of total global reserves

However, when it comes to production, the top five producers are China, the U.S., Myanmar, Australia, and Thailand, commanding nearly 98% of the market, with China, the U.S., and Myanmar contributing an overwhelming 90.96%. Consequently, any fluctuations in production capacity from these nations will profoundly impact global rare earth supply.

As China closely regulates its rare earth output, the country has experienced significant growth in total mining quotas over the past three years, exceeding 20%. The trend seems set to continue into 2024, though growth in quotas is expected to taper to single digits

Additionally, the government mandates various departments to strictly supervise and manage the entire supply chain from mining to product distribution and import-export activities, stringently controlling rare earth availability to alleviate inventory pressures.

As China continues to tighten its overall output controls, a scenario may emerge where the supply of rare earths fails to meet rapidly rising domestic demand, creating a space for imports to fill the gapMyanmar, sharing a border with China, is crucial in this context

Representing the third-largest global producer, Myanmar supplies more than 40% of China's rare earth importsHowever, should the region remain closed off from trade, China would face a significant shortfall in supply, leading to potentially skyrocketing prices and suggesting a simultaneous increase in both volume and value within the industry.

Moreover, the intertwined political relationships between China and the United States could further complicate the rare earth market landscape

With recent tariff hikes imposed on rare earth imports from China in May 2019 leading to a price rebound exceeding 100% by the end of Donald Trump's term, historical patterns suggest that upcoming policy suggestions may similarly sway the market dynamics.

Key Players in the Supply Chain

As expectations for industry fundamentals shift, questions arise regarding which sector players stand to gain from an optimistic outlook and which will attract investor interest amidst these changes.

The rare earth supply chain is structured hierarchically with upstream activities focusing on mining, separation, and smelting, characterized by high concentration due to regulatory frameworks

The industry leaders include Northern Rare Earth and China Rare Earth HoldingsThe midstream encompasses various sectors, primarily involving the production of rare earth permanent magnet materials and luminescent materials, where key players such as Jinli Permanent Magnet and Zhenghai Magnetic Materials lead in the permanent magnet domainMeanwhile, downstream applications cover diverse end users, including wind energy, electric vehicles, and industrial motors.

Northern Rare Earth, listed on the A-share market, stands as the world’s largest and most lucrative player in rare earth processing, actively expanding its footprint to include magnetic materials and motor production sectors

However, 2023 witnessed a significant downturn in its performance attributed to the continuous drop in rare earth prices, leading to a considerable decline in net profit by above 70% compared to previous year figures.

Despite these challenges, Northern Rare Earth’s resilient position based on supply advantages allows it to weather the volatilityHighly sensitive to price fluctuations, a rise in the price of praseodymium and neodymium oxide by varying degrees indicates that the company’s profits could see substantial improvements, demonstrating a potential for significant upside with minor shifts in pricing.

Jinli Permanent Magnet operates aligned similarly within the midstream market

While their reactive performance to upstream price changes is relatively sluggish, they still face industry-wide pressuresHistorically, the company experienced significant revenue growth followed by a tapering trend, showcasing resilience against upstream volatility yet suffering substantial drops in profit margins.

Jinli Permanent Magnet boasts ambitious growth targets, with plans to reach a production capacity of 40,000 tons of neodymium iron boron by 2025 and ongoing improvements in product structure, particularly in high-performance materials

Their efficient production utilization rates exceeding 90% in 2024, along with a robust growth trajectory of over 40% in high-performance material sales, display factors supporting their optimistic outlook in an otherwise challenging climateThey are also venturing into humanoid robotics, tapping into new growth avenues.

Apart from these leading companies, other players in the sector, including China Rare Earth, Baotou Steel and others, are set to benefit from this forthcoming price recovery as well

Still, key institutional investments are earmarked for industry leaders, with Jinli Permanent Magnet coming across as a favorable and attractive option, in terms of better valuation compared to Northern Rare Earth.

With a low valuation and structural premium on AH shares standing at 100%, Jinli Permanent Magnet's PB ratio at 1.73 times is considerably below the industry's average, reflecting their generous dividend payouts averaging at 48.6% annually over the last three years and a staggering 89% for the first half of 2024. Under the backdrop of gradually recovering pricing dynamics within the industry, supportive downstream demand, and capacity releases, Jinli Permanent Magnet could well attract long-term investor interest.

From the perspective of investment banks, the outlook on the rare earth industry's future remains remarkably positive

Tianfeng Securities’ research indicates that the existing landscape of the rare earth sector has undergone significant transformations, where both supply and demand have been reshapedThe prevailing demand now leans heavily into sectors driven by renewable energy and energy efficiencyFurthermore, infrastructure upgrades and consumer replacement policies will likely stimulate new demand across various spheres such as motors, air conditioning, and elevators, suggesting a dynamically growing sector in the years to come.

Guoxin Securities has also issued favorable reports on Jinli Permanent Magnet, emphasizing the critical role of neodymium iron boron materials in the energy-saving and carbon-reduction sectors

They highlight the company's competitive edge in management, technology, and customer engagement, strengthening their profitability and growth potential and positioning them to emerge as a global leader in the high-performance neodymium iron boron material market.

In conclusion, after three long years of price contractions, the rare earth market appears poised for recoveryAs fundamental shifts in the industry landscape unfold, participants within the supply chain are expected to gain significantly, potentially enjoying both earnings and valuation rebounds