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2012: The Recognition of the Age of Critical Technology Materials

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"The rare earths supply frenzy has exposed an irreversible shift in the demand/supply picture for all technology materials."

The following essay was written over New Year’s weekend, 2011-12. My theme is that the rare earths supply frenzy has exposed an irreversible shift in the demand/supply picture for all technology materials, not just the metals, but also the energy minerals, and the minerals necessary for agriculture. The only mining ventures today that have the potential to be profitable on a stand-alone basis are those that can produce at the lowest cost in the global marketplace, and the breakeven point of which is low enough so they can maintain production at very low levels, thus holding on to their customers.

America’s technology materials mining industry can prosper now only by vertically integrating to supply the domestic market first. Surplus production can be exported from several points of a total supply chain, thus reinforcing capacity flexibility and dropping the breakeven point for the whole supply chain. This is smart globalization. Just as an aircraft flight attendant tells you to connect your oxygen first before trying to help anyone else I am telling you to build total supply chains for technology materials domestically to ensure that you can help yourself before you try to help others.

Note that by "American-I mean North American. The North American market for producing end use technology materials is 90% in the U.S., but the production of those materials and at least half of the requisite supply chains can be constructed in Canada. There has never been a better opportunity to make NAFTA into the basis for a world-class technology materials production economy. All that is really needed now is insightful finance and much better educated legislators driven by something other than reelection and greed. Call me a cynic, but Happy New Year.

The unprecedented and unexpected growth in total demand for technology materials for the production of fabricated goods, energy and food since the beginning of the 21st century has changed the dynamic of the global materials market.

The response of American- and European-style capitalism to this sudden rush of demand has until now been to treat it as a problem to be resolved along traditional lines by raising the prices of the affected "commodities" until the "opportunity for profit" thus created resulted in additional supplies to relieve, or at least, to limit, the upward price pressure. "Demand will create supply" and “shortages will be ameliorated by surpluses" were among the responses I heard from American and European industrial procurement and planning managers. I was among those who then raised the "security of supply", issue only to be told that it was a nonissue due to the fact that the amounts of all materials in the earth’s crust made the potential supply infinite.

It was impossible at first, and it is not much easier now, to explain to industrialists and financiers that only resources the mineral deposits of which are concentrated enough to be recovered and purified by known and economical technologies can be called even potential supplies. The greed, short-sightedness, and poor general science education of our current politicians, industrialists, and financiers has let America and Europe sit back and not only observe but actually assist our economic competitors to gain such an advantage over us through focused acquisition and management of natural resources that the U.S. and Europe, in order to survive economically, must now restructure our financial as well as our remaining industrial assets in the hope of salvaging some competitive advantage through maintaining a lead in technological innovation.

Yet like the Mahdi’s soldiers, who wore talismans to ward off bullets, our financial, industrial, and political elites raise the banner of an outmoded form of independent operator capitalism to ward off the advances of a differently structured and focused Asian capitalism wedded directly to the finances and centralized direction of an immense nation able to drown the individual western capitalists in a tsunami of money not for the sole purpose of acquiring more money but mainly to acquire ownership and control of critical natural resources so as to make their home nation(s) self-sufficient in natural resources and energy.

The western capitalists serve the purpose of the eastern capitalists by choosing to concentrate on short-term gains while the Chinese, for example, acquire resources for their use to create products and jobs not for speculation.

The problem of course arises from the fact that this growing demand for natural resources has not been created by the U.S., Europe or Japan, but almost solely, at this point, by a new player on the world trading stage, the People’s Republic of China (PRC).

I believe that 2012 may finally see a recognition by western strategic investors that the long-term outlook for the global demand for technology materials is one of continued high net growth, and that the present rate of supply of these materials already is at the point where it cannot even now keep pace.

Junior miners, which are basically exploration companies, playing the same old game of appearing to be on the cusp of "rushes," are really just bit players in the new world of natural resource supply. The economic cycles and turmoil in the old capitalist societies of the west and of Japan have taken precedence in the news over the dramatic growth of overall demand for technology materials, but the focus on short-term gain from trading junior mining shares in a casino atmosphere is no longer viable when looking at ensuring the security of supply of technology materials.

Ownership of ore bodies and other such natural resources are only of long-term value when they are developed to the stage where they contribute directly to Increases in the rate of production of technology materials. This requires years of planning and continual development. This cannot be achieved just by issuing shares to raise capital. The share market for technology materials’ producers is rapidly becoming a sideshow. China seems today to be the only nation-state with both an existing industrial policy and the capital and command organization to carry it out. Like the Soviet Union before it, the PRC plans its economy in five-year tranches. Also, like the Soviet Union before it, the PRC sets higher production targets for goods and services with each successive five-year "plan." But the PRC also measures the success of a five-year plan by the increase in employment and improvement in the standard of living it brings about. The Soviet Union pretended that it was always at full employment. The planners of the PRC do not seem to follow this tradition.

The key to future wealth is the ownership and control of total supply chains for the production of technology materials. There are no short cuts.

In the western markets, tumbling share prices and suspension of IPOs on news of temporary declines in demand or temporary oversupply are simply casino gambling, and if that is the best that the so-called free market can do then China will be the clear long-term winner in the technology materials’ self-sufficiency stakes. In order to be a competitive economy it is necessary for a nation to have access to the natural resources it needs so that its economy can grow. The development of such resources can no longer be left to short-term planning. It is necessary to commit both capital and intellectual capital to the long-term development of adequate and sustainable production rates of natural resources. Baselines must be established for nations, and the development of the resources necessary to maintain those baselines and allow for growth must be a priority of the nation’s markets.

This didn’t come about overnight. This situation has been building since the making of money for the sake of having more money eclipsed the making of money from increasing productive commerce.

The economic cause of the transfer the world’s trading and manufacturing center from America to China has been American capitalism, which seeks the lowest cost for all resources, goods, and services in a system of as much global free trade as is compatible with minimizing national and international taxation, i.e., maximizing profit. American-style free-market capitalism does not believe in natural resource exhaustion except as a scare tactic to drive share or commodity prices. In fact, it is the maximization of the rates of production of natural resources that is the problem from the point of view of the long-term allocation of capital for most non-energy extractive industries.

Increasing the rate of production of extractive resources is capital-intensive and time-consuming, which means, of course, that it must be a low-profit endeavor when ranked against speculation.

Twenty-five years ago, when the transfer of labor-intensive repetitive operations to low labor-cost countries was begun in earnest, the main driver for American industrialists was cost-control as a method for the retention of market share in a very competitive marketplace, then just beginning to feel downward price pressure from Asian, predominantly Japanese, imports. A second, no less important, driver at the time was the maintenance of the industrial company’s share price. This was in the era of blue-chip stocks, which were defined as those of the largest producers of raw materials, energy, or finished goods in an era when banks were service industries. Money was to be made through profit margins on goods and services. Banks were providers of the service of lending money to blue chips mainly for cash flow or working capital purposes. Investment "banks" took new ventures public and the partners in those banks had their own money at risk first of all.

The until now unnoticed political driver that allowed the transfer of low-cost manufacturing to China, in particular, was the desire of the ruling communist party of the People’s Republic of China to use the situation (the desire of the capitalists for low-cost labor) to literally force-start and then accelerate China’s development into a modern military-technological-industrial state. As Deng Xiaoping had put it succinctly, the idea was to make China "strong and rich." A version of capitalism was to be allowed, albeit one with Chinese characteristics so that the nation could be put onto a path that would lead it to being able to provide its average citizen with the safety, health and material wellbeing already achieved by the nations of the west of which the paragon is the U.S. Of course, this would come after or at the same time as China grew in strength to "resume" its natural place among nations.

On Friday, December 30, 2011, the Chinese government announced that China would put men on permanent duty in an orbital space station before 2020. Such an announcement in 2000 would have been considered "crackpot" at best. What a difference a decade of GDP growth at 10% per annum makes!

I have thought, and I have been trying to point out for many years now, that apocalyptic theories of supply shortages and of subsequent rampant price inflation supposedly due to peak natural resources, i.e., the exhaustion of natural resources, are based on the type of reasoning that confuses the disease with the symptom. The disease is the financialization of capital, which means that the majority of investments made in the West today are completely detached from any relation to the production of commerce at all. Money is being used primarily for pure speculation. The purpose of such types of investments is solely to make more money. The confusion between wealth creation (jobs, goods and services) for productive purposes and the simple making of money, for no other reason than to make more money, by the press, the politicians, and the ordinary citizen has masked this societally suicidal frenzy until it has now resulted in the downgrade of the American standard of living for the vast majority, and the placing on the path to extinction not only the contemporary middle-class but also the pathways to entering and remaining in that class.

The American governing classes have purposefully joined the financial elites and insulated themselves from this downgrade, which has now moved beyond their understanding. They have assigned the solution of the financialization crisis to those whose lack of interest in the wellbeing of the nation is manifest—the bankers, who in fact brought on the American abandonment of wealth creation for productive purposes as a status game enshrined in the corrupted phrase, "Him who has the gold makes the rules."

American industry literally taught the world how to build and equip workshops to economically mass produce consumer goods. The industry was financed by a capitalism that counted success as the marketing of mass-produced products made at the lowest cost that could be sold at a profit.

America’s industrialists never worked under a national industrial policy, so that when the opportunity arose to lower costs simply by exchanging the American for a lower cost labor workforce there was no ethical barrier. The short-term goal of maximizing profit was paramount. No one was concerned with the long-term consequences of such a move to the workforce much less to the country as a whole.

Keep in mind that financiers backed the moving of millions of jobs to low-cost labor countries while politicians never even gave a thought to the effect on the economy of the ensuing unemployed masses. As I recall, we were told that "service" jobs here would replace those lost to low-cost labor countries. It was never clear exactly what the economic pundits were defining as service jobs. We now realize that was because they didn’t know what they would be either.

So why should investors in natural resources care about the sad history of American corruption, greed and sheer stupidity? It’s because one of the totally unforeseen long-term consequences was the shift to Asia of the demand for not only the final assembly and the manufacturing of the parts necessary for such assembly, but ultimately of the total supply chain beginning with and including the mining and refining of the minerals. This shift has meant the loss of not only the physical plant for total supply chains but the withering away by the attrition of non-use of the intellectual basis of such industrial processes.

The rare earth supply situation, which has been highlighted in the U.S. for the last few years, is just the tip of the iceberg, the body of which is the loss or collapse of the capability to build or operate a total supply chain for a given critical material when the first steps of that supply chain have been moved offshore.

Clueless and engineering-ignorant American environmentalists for whom mining and refining are simply evil incarnate have managed over the last generation to force reelection-only driven legislators to favor the closing of sites producing natural resources for energy and manufacturing and the imposing of regulations that make such production simply too time consuming as well as adding enormous costs.

The dwindling proportion of capital targeted to increasing productive capacity remaining in a system being squeezed dry of such capital by pure financial speculators seeking short-term gain has now made it more productive to move entire supply chains offshore, to where the raw materials can being mined and refined, rather than to waste capital on endless regulations and battles with the ignorant and suicidal (or ignorant and rich). The result has been at best to increase the cost of restarting a supply chain and, at worst, to make it intellectually impossible if only domestic resources are to be utilized.

I note in passing that America’s most important remaining engine of wealth creation is its innovative high-tech industries. These industries, such as electronics and healthcare, have been responsible for more improvement in the standards of living and lifestyle of the peoples of the world than any other intellectual force in history. The American electronics, aerospace and nuclear industries have held out offshoring their research and development, but sadly they have only managed to do that by enticing the best of the Asian students to come and work in the U.S.

For a generation this worked well, because such individuals for the most part preferred to stay in the U.S. to utilize their American-honed and learned skills to enjoy a better lifestyle than they could at "home." And to have the opportunity to create their own businesses. Today that situation has changed, as places like China and India have improved enough in opportunity-availability to entice their brightest and best to stay home or even to come home. The American mining and refining industry has also had its share of bringing skilled Asian workers and engineers to the U.S. from China and India, and like the high-tech manufacturing industries it has now seen the outflow of these same people with their American-honed skills and technological improvements back to their "home countries." Asian engineers who specialize in mining and refining engineering are very unlikely to remain in an America that blocks them from opportunity at every step.

America’s greatest inherent advantage in the production of natural resources is based on
  1. The variety of items in which North America can be self-sufficient,

  2. The safety of American natural resource production, and

  3. The productivity of North American mining technology and personnel.

The hypocrisy and sheer stupidity of those who want to stop producing natural resources in North America so that we can get them from places where civil liberties are frequently nonexistent, productivity is low, safety is poor, women are treated worse than domestic animals and the standards of living are appalling, is simply beyond understanding.

I think that January 1, 2012, is as good a date as any to focus on the fact that maintaining a steady flow of affordable raw materials for energy production, food production, and manufacturing all at prices we can afford, which will let our economy grow without lowering our standard of living is now the imperative.

The problem is that while we are trying to maintain production levels and costs the BRICs (Brazil, Russia, India, and China) are trying to increase the production of the same materials at a rate never before seen in history. It is unlikely that America can ever again be a major supplier of extractive resources to an export led domestic manufacturing industry. We have waited too long and have simply lost the will and the capability to restore that capacity.

We can, however, conserve capital and reduce debt by becoming self-sufficient in energy and by again being entirely self-sufficient in metals and minerals for our domestic needs. The demand for technology materials of all kinds is ultimately now and in the future to be driven by the BRICs, as all of them struggle to build military-technology-industrial complexes. The U.S. cannot hope to supply the BRICs with structural metal ores or fabricated products, because we waited too long to get into the game. Our structural metal industries cannot now, and have been unable to, compete with those of China or India on price since at least the middle of the last decade. The move to financialization destroyed any hope of American financiers creating truly global metals and minerals giants such as Rio Tinto or BHP. However there is still time remaining for the U.S. to become a technology materials powerhouse for ourselves and for the world.

The U.S. and North America are rich in the extractive resources of the metals and minerals that are critical to mass-producing high-tech devices for all uses, civilian and military. The U.S. and Canada combined currently also lead the world in mining and refining engineering as well as technological innovation. The U.S., however, is entering upon the last decade during which it has a chance to return to self-sufficiency and innovative leadership in technology. Once these opportunities are gone the world will have passed us by, and the result will be the slow erosion of our standard of living and of any further opportunities for growth. Canada has been a patient partner, our largest supplier of natural resources, but Canada’s population cannot support the creation of enough capital to move North America into the position of the world’s premier and central supplier of technology materials.

Small investors need to take note that the first decade of the 21st century saw more change in both the movement and the composition of the world’s metals markets than any other comparable period in history. The changes are permanent and their cause is an irreversible and fundamental change in the geography of the global raw materials trade. The driving center of the trade is no longer in the West; it is today in East Asia.

I believe that you can safely relegate the bulk of 20th century punditry and scholarship on the cycles of the production and prices of metals in peacetime to the scrap heap. There they join such ideas and common wisdom as "the end of history" and descriptions of China as a third-world or developing country. In 2011 as in the prior decade, China and the other "developing" countries of southeast Asia continued to grow their GDPs at a rate of at least three, and as much as four, times the pace of the U.S. or Europe. And since their common target, not their target in common, is to develop technology-military-industrial economies with a per capita GDP at least equal to that of the pre-2008 U.S. the rapidly growing economies of the nations of south and east Asia, and soon, if not already, of Brazil, are consuming, in an unprecedented accelerated timeframe, the same volumes of base metals, mainly for fixed infrastructure and for transportation, that the U.S. and Europe produced and consumed in the from the beginning of the age of steel, 1867, until now!

The strain this acceleration of and growth of demand has put on the world’s productive capacity for the ores of the base metals has now highlighted the differences among the base metals themselves by resolving them, by use, into the structural metals and the enabling structural metals. China alone today, in 2011, already uses 60% of all of the iron ore mined globally and 33% of the aluminum ore. Huge investments of capital in the ores of both of these base structural metals have been made outside of China solely for the purpose of supplying just China. Investors should note that unless the demand for base structural metals grows in the other BRICs—the resource-rich and/or resource mega-demanding nations of Brazil, Russia, India, China and South Africa—China could create chaos in the world iron-ore market simply by increasing its domestic output to self-sufficiency, which is, in fact, possible, although not today economical. This game-changing event, Chinese self-sufficiency in iron ore, which is actually predicted by Rio Tinto to take place by 2020, would, without a buildup in demand outside of China, throw global iron ore production into a vast oversupply status thus collapsing prices. By simply, albeit expensively, moving forward towards self-sufficiency, China puts downward pressure on global iron ore prices. Strategic investors should now look for the most efficient low cost producers and fabricators of steel and aluminum outside of China, because the creation of a massive non-Chinese demand is absolutely necessary for the non-Chinese owned iron ore industry.

The ores of iron and aluminum are available in proven accessible deposits in great abundance. The proven resources of these ores are sufficient even at present global demand to sustain the global steel and aluminum industries for centuries. As long as energy is plentiful and relatively cheap the global production of steel and aluminum will continue, but continue to grow only through demand from the "developing" countries. Strategically, I think that Russia is far from any meaningful development. I am looking at India and Brazil as demand drivers for iron and aluminum. Both are today self-sufficient in iron ore and both are world-class exporters. Note well though that should either’s economy ever require the importing of iron or aluminum ore while at the same time Chinese demand were stable at today’s rate, or continued growing, there would then be a run-up in iron ore prices that would dwarf those of the last 10 years. In that case Australia would be the big winner. Australia’s demand for steel can never require more than a small fraction of its capacity to supply of iron ore. The unknown factor in all of this, in the long run, is China, which could become an exporter of iron ore in the 2020s.

Whatever commodity scenario one plots for the long term it is now always Asian demand that is critical. America’s future is tied to sophisticated supply chain developments for natural resources.

I personally do not believe that China will become an exporter anytime soon of iron ore, as a raw material, unless such action becomes necessary to maintain employment in the Chinese mining industry, and then only after domestic demand is satisfied.

Additionally it should be noted by strategic investors that a China, self-sufficient, or in an ownership situation globally of resources to make itself self-sufficient, in iron ore, coking coal, limestone, bauxite and cryolite, could easily come to dominate the global supply of steel and aluminum.

It is ironic that monopoly capitalism with Chinese characteristics is the true threat to so-called free market capitalism, which considers monopoly capitalism to be counter-productive to the fair distribution of wealth because it concentrates wealth in too few hands and hands pricing power solely to the monopolist. Yet the Chinese have chosen state monopolized capitalism to ensure the distribution of the wealth created to the largest number of Chinese people. The Chinese system is as much a threat to western economic philosophy as it is a threat to western lifestyles and standards of living. The biggest problem is that even as production rate investments consume more and more western capital it is not at all clear that the prices for the materials so produced will be set by a free market. Thus, such investments are high risk—in fact, this is exactly the problem in the current rare earths production buildup. There has been almost no change in the geographic center of rare earth demand—China. This means that Chinese moves to regulate its environment, improve worker health, safety, and compensation, and to direct its economy away from being export led to being domestic consumer demand driven will be the drivers for rare earth pricing. When one takes into consideration that Chinese moves into global finance are targeted so as to keep Chinese manufacturing competitive, this means ultimately a convertible currency in which raw materials such as the rare earths are denominated.

So long as America is dominated by a Wall Street and Washington elite that believes that a man’s worth is measured by the capital he accumulates, whether or not it is used productively to make products and create jobs, there is no contest. China is winning.

Jack Lifton, Resource Investor

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