In a twist, traders have found a hot new bet in China's stock market that has churned out jaw-dropping gains specifically because of deteriorating US-China relations: rare earths.
While the benchmark gauge Shanghai Composite Index has remained in the doldrums over the past month amid the trade stand-off between Beijing and Washington, China Minmetals Rare Earth, China Northern Rare Earth (Group) High-Tech and other major producers of the elements have shot up at least 34 per cent, making them the hottest trade on the mainland's exchanges.
A slew of recent high-profile moves by the Chinese government to stress the strategic importance of rare earths fuelled speculation that the raw material, used in everything from Apple's iPhones to Tesla's electric vehicles, will be employed as a high-stake bargaining chip in the US-China trade dispute. China is by far the US' biggest supplier. Hype around rare earths has been in high gear since the Trump administration blacklisted Huawei Technologies, banning the Chinese telecom equipment maker from buying American chips and technology.
"If there is a disruption of supply, the hi-tech industries in the US will be affected and that'll lead to an increase in rare earth prices," said Ken Chen Hao, a Shanghai-based strategist at KGI Securities. "As long as the trade tension between China and the US carries on, the hot play on rare earth stocks will remain there."
China dominates global supply of rare earths, 17 elements on the periodic table with names like europium and ytterbium that share similar chemical and physical properties. It is the world's biggest refiner of the metals, accounting for 90 per cent of global production, while the US is the largest importer, with 59 per cent of its imports sourced from China.
A visit by President Xi Jinping and his top trader negotiator Liu He last month to a publicly traded rare earth-processing company in Jiangxi province, one of the main regions producing the raw material in China, marked the prelude to a slew of government propaganda. Just days later, the nation's top planning body said rare earth supply will serve domestic needs as a first priority. Last week, the planner coordinated three government departments in a field trip to rare earth-rich regions, gleaning information and comments on how to make better use of the metal.
Traders cheered the moves, anticipating that the attention by the top policymakers to the industry will lead to a rapid increase in rare earth prices. Such optimism has been quickly reflected in the stock market.
Shares of JL MAG Rare-Earth, the company visited by President Xi last month, have surged 191 per cent over the past month. China Minmetals has climbed 52 per cent in the period and China Northern Rare Earth 34 per cent.
Still, some investors remain vigilant of the outsize gains, arguing mere policy support will not translate into an immediate improve in earnings.
"The outlook of the sector largely hinges on the progress in the trade war," said Wu Kan, an investment manager at Soochow Securities in Shanghai. "If there's a detente, the rally will lose its momentum quickly. It's mostly an event-driven thematic investment and these stocks are good for day trading, but not a long-term buy given no sign of a pickup in earnings."
Even by the standard of the median estimate of earnings for next year, JL MAG trades at a multiple of 107 times, according to Bloomberg data. China Northern Rare Earth is valued at 79 times, the data showed. The prices of so-called heavy rare earths, which are used in batteries for new-energy cars and in defence applications, have risen 30 per cent this year.
The latest data from the customs office may give traders some sign of relief, as falling exports of the metal suggest the Chinese government may have already started to curtail the overseas shipments amid the deadlock over trade negotiations. To them, that means the rally on rare earth stocks will not fizzle out any time soon. Rare earth exports fell 16 per cent from a month earlier in May and dropped 7.2 per cent from a year ago in the first five months of the year.
It is not the first time that China has banked on its global dominance of rare earth supply to exert influence in resolving political disputes. In 2010, China suspended exports of the metals to Japan for two months and subsequently announced a massive cutback on export quotas in a territorial conflict with its neighbour. That drove up prices of the raw materials by at least six fold.
For Gerry Alfonso from Shenwan Hongyuan Group, rare earth stocks may be in for a wilder ride going forward, with the Group of 20 meeting that presidents Donald Trump and Xi will attend drawing nearer. It remains unknown whether Xi and Trump will meet and engage in further talks at the two-day summit scheduled through June 29 in Japan. Trump demanded a meeting with his Chinese counterpart, threatening to raise tariffs again otherwise.
"In my base case scenario, some of those stocks still have upside, because they are easy to forecast stable cash flows as well as a low base effect," said Alfonso, director of international business department at the Shanghai-based brokerage. "However, the macro environment remains unclear, likely adding volatility in the short term."
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