REMX - REMX: High Geopolitical Risk Will Lead To Diversified Supply Chains

2023-12-14 09:06:18 ET

Summary

• VanEck's Rare Earth/Strategic Metals ETF warrants a sell rating due to geopolitical concerns regarding its top holdings in China.
• REMX has a high expense ratio, poor recent performance, and a low dividend yield compared to peer ETFs.
• Investors would be better suited with ETFs that have more internationally diversified holdings, particularly with lower weight on Chinese companies, to mitigate geopolitical risk.

Investment Thesis

VanEck's Rare Earth/Strategic Metals ETF (REMX) warrants a sell rating due to geopolitical concerns regarding its top holdings in China. Due to China's tightening of exports, the U.S. and other nations will likely seek diversified production of precious metals mining and refinement elsewhere in the world. Additionally, REMX has a high expense ratio and poor recent performance compared to peer ETFs. Investors would be better suited with ETFs that have more internationally diversified holdings, particularly with lower weight on Chinese companies, to mitigate this geopolitical risk.

Fund Overview and Compared ETFs

REMX had an inception in 2010 and seeks to track the performance of the MVIS Global Rare Earth/Strategic Metals Index . Therefore, the fund has holdings in companies that mine and refine rare earth strategic metals and minerals. REMX has 92.80% weight on the materials sector, 6.96% in industrials, and 0.24% in other/cash.

REMX's largest geographic net asset allocations are Australia (34.27%) and China (30.54%). Following these top two, Canada, U.S., and Chile also have weights of greater than 6% each. There are 17 rare earth elements that exist including Dy (Dysprosium), Ce (Cerium), Nd (Neodymium), Y (Yttrium), and La (Lanthanum). These rare elements are currently critical in the manufacturing of cell phones, electric vehicles, and other products. China currently has the largest share of rare earth metals production.

Peer ETFs used for comparison purposes are iShares MSCI Global Silver and Metals Miners ETF (SLVP), iShares MSCI Global Metals & Mining Producers ETF ( PICK ), SPDR S&P Metals and Mining ETF ( XME ), and Victory Precious Metals and Minerals Fund ( USAGX ). While these other ETFs contain more prevalent metals such as iron, gold, and silver, these funds are used for comparison purposes.

Performance, Expense Ratio, and Dividend Yield

The rare earth metals market is expected to see a 7.4% CAGR through 2030 . However, overall performance of REMX has been below average compared to the S&P 500 index for virtually any period examined. REMX has seen a 5-year CAGR of 4.73% and lifetime CAGR of -7.50%. By comparison, SPDR's S&P Metals and Mining ETF has seen a 5-year CAGR of 15.3% and a positive return since its inception in 2006.

Beyond performance, REMX's expense ratio and dividend yield do not particularly outshine other mining ETFs. With an expense ratio of 0.54%, REMX is more expensive than most examined peer ETFs. While REMX offers an annual dividend of 2.07%, its 5-year dividend growth CAGR is -14.58%.

Expense Ratio, AUM, and Dividend Yield Comparison

Source: Seeking Alpha, 10 Dec 23

REMX's Holdings Versus Competitor ETFs

REMX has 34 holdings. Compared to peer ETFs analyzed, REMX has the greatest weight on Chinese companies at over 30%. While most of the world's rare earth metals are in Asia (37.9% in China, 18.9% in Vietnam, 5.9% in India, and 10.3% in Russia), North America and Africa also have notable reserves.

In contrast to REMX, SLVP has over 60% weight on Canada and U.S. mining companies. Additionally, USAGX has over 70% on North America and PICK is heavy on Australia, Brazil, and the United States. Because only 1.3% of rare earth metals known to be in the U.S. and another 0.7% in Canada, any ETF avoiding China entirely will likely be difficult. However, given recent geopolitical risks, any rare metals ETF that has such heavy weight on China carries significant risk.

REMX Top 10 Holdings, Weight, and Company of Origin Listing

Source: VanEck.com, compiled by author on 10 Dec 23

This risk has also been seen in individual holding performance. For example, China Northern Rare Earth Group is down over 25% YTD. Xiamen Tungsten, another Chinese-based rare metals company is also down 14% YTD. In contrast, iShares ETF, PICK, has only 1.94% weight on China. As a result, its performance has been much better with heavier weight on companies like Rio Tinto, a British-Australia company, that mines the rare earth metal scandium.

China's Rare Earth Metal Export Limitations and Consolidation

In 1992, Chinese leader Deng Xiaoping stated "the mid-East has oil, and China has rare earths". Given what is close to a monopoly, China is the source of 80% of U.S rare metal imports. This presented a startling geopolitical risk when the Chinese government announced earlier this year that they would limit exports for rare earth metals gallium and germanium. Signs also point to China consolidating its power over companies and increasing restrictions on other rare earth exports.

The West's Response

In response, the U.S. is taking direct action to diversify its reliance on China for rare metals. Former President Trump signed a package that included $800 million in rare earths programs to buy "American first". President Biden also has taken action with directives aimed at supporting U.S. companies. One example of a U.S.-based rare earth metal company is USA Rare Earth. While currently a private company, USA Rare Earth is exploring potential listing on the NYSE . Investment by the U.S. government on domestic rare earth metal companies will likely lead to increased supply. Multiple rare earth metals are also capable of being recycled as well. This response appears to be effective so far, with China's global rare earth metals production dropping from 80% in 2017 down to 60% in 2021.

REMX and Looking Forward

So, what does all this mean for REMX? Due to the diversification of supply already seen, the price of rare earth metals has declined. This has subsequently resulted in REMX's poor performance. The trend of greater diversification for rare metal supply will likely continue. The U.S., and its allies, will likely seek imports from Brazil, India, Vietnam, Australia, and South Africa. This will continue to dampen returns for Chinese-run rare metal companies. As long as REMX holds a significant weight on these Chinese companies, other peer competitors will do notably better.

Valuation and Risks to Investors

With a price of $56.96 at the time of this article, REMX is in the lower range of its 52-week range ($53.97 to $98.28) and well below its all-time high of $121.98 seen back in March 2022. Despite dropping 23% YTD, REMX indicates multiple metrics that are not convincing as a buy for me including its P/E and P/B ratios.

While having a price-to-earnings ratio and price-to-book ratio on the lower end compared to other mining peers, the geopolitical risks outweigh any undervaluation metrics in my opinion. PICK, already mentioned for its lower geopolitical risk in holdings and better performance, has a more attractive P/E and P/B compared to REMX.

Valuation Metrics for REMX and Peer Competitors

Source: Compiled by Author from Multiple Sources, 10 Dec 23

Additionally, REMX has a beta value of 1.39 compared to the S&P 500 index. In contrast, SLVP has a 3-year beta of 0.83 and USAGX has a beta of 0.82. Given the likely diversification efforts by the U.S. and other countries, I expect REMX to continue to underperform while it has a significant weight on Chinese-controlled mining companies. Other ETFs like PICK or USAGX with heavier weight on domestic and U.S.-allied nations will likely outperform.

Concluding Summary

REMX warrants a sell due to its high level of geopolitical risk with few reasons to expect high performance going into next year. The ETF has a high expense ratio, negative dividend growth CAGR, and declining performance. Given the current geopolitical climate, the U.S. and other nations will likely continue to see strategic competition over rare earth metals needed for cell phones, electric vehicles, and numerous other applications. Therefore, one can reasonably expect nations to seek diversified supply chains, hurting Chinese-based rare earth metal companies. This will have a direct impact on REMX. I personally will also be on the lookout for U.S.-based companies going public (and ETFs that include them) that either mine, refine, or recycle rare earth elements.

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