iPhones & Teslas: 2 Rare Earth ETF Bets

September 10, 2014

With so much focus on new tech, is there a hidden play in ETFs?

I get it. I’m a gadget freak too. I wear a UP24 fitness tracker. I carry an iPhone and an iPad with me pretty much everywhere. I lust after a Tesla Model X to replace the family minivan. And while plenty of investors have piled into the companies delivering us these innovations—witness Apple’s half-trillion-dollar market cap, and Tesla’s $35 billion—I sometimes think that misses the point.

Investing is often about finding the scarcity and grabbing hold. Yes, of course, investing in companies that will generate earnings over the long haul through innovation, savvy marketing and superior execution is fantastic, and that’s what Apple and Tesla owners are hoping for.

But often, finding the corners of the market where someone has something everyone needs is a great way to play long-term defense.

So what do the gadget makers really need? Well, talent and capital, for sure.

Expensive Dirt

They also need dirt, the really expensive kind of dirt. Call them “rare earth” or “strategic metals,” the tech economy is enormously dependent on metals like zinc, lithium and germanium to make all the cool stuff I always end up buying. And it turns out, there’s a lot less of that stuff around than we might like—hence the “rare.”

The Wall St. Journal covered the situation in one metal today—zinc. Compared with some of the more exotic elements, zinc is still relatively abundant, and isn’t even considered a rare metal, just a base one. But it’s starting to get thin in the warehouses. Metals like lithium—the key element in all those Tesla batteries—are facing much more significant crunches.

And yes, there are ETFs to play this trend of scarcity.

The purest play is the Global X Lithium ETF (LIT | D-91). It holds the 20 most important lithium-focused companies, and is in fact a great pure play—as its ETF.com “Fit” score of 91 suggests. The issue for investors is that it has consistently

Lit

 

Some of this underperformance is explained by its relatively high expense ratio of 75 basis points, or $75 for each $10,000 invested. The rest, however, comes down to poor tracking by the issuer. The median tracking difference versus its own index is -1.27 percentage points, meaning on any random one-year holding period, that’s what you’d expect to be behind.

To be fair, the portfolio itself is super-concentrated—just two companies make up almost 40 percent of the portfolio, and it dips all the way down into micro-cap territory in places like Chile, so some slippage of performance relative to its index is probably inevitable. Still, investors should be cautious.

Luckily, there are other ETFs with which to invest in the demand for these strategic metals. The cleanest and most ownable example is the Market Vectors Rare Earth/Strategic Metals ETF (REMX).

With almost $93 million in assets, and a bit more sensible 57-basis point expense ratio, REMX is a well-run fund that consistently beats its own index, likely through aggressive optimization of the smallest stocks. That’s important, because REMX’s focus on the super-narrow, rare-earth pure plays means it holds stocks that go way, way down the cap spectrum.

While REMX holds just 22 companies, 40 percent of them fall below our micro-cap threshold of $600 million. Those companies come from all over the world—China, Australia, South Africa, even Ireland. And these are pure plays.

The biggest holding, Trunox, is the world’s leading titanium supplier. The No. 2 holding, Iluka Resources, has pretty much cornered the market on zircon. The fund’s smallest holding, General Moly, is a key miner of molybdenum—and, with a market cap of just $83 million, small is the operative word.

Not all of these materials are tech-focused. Zircon is primarily a ceramics component, and titanium and molybdenum get used all over the place, but they nonetheless still capture the future-scarcity theme.

Alas, recently, this concentration on the theme has produced a profile only a downhill skier could love. In just the last year, it’s down almost 16 percent, while the S&P 500 Index is up over 22 percent.

REMX

And this highlights the real issue with chasing a narrow theme like rare-earth scarcity with an ETF, or even with individual stocks. While it’s inevitably the case that growing populations combined with a growing appetite for high-tech goods will drive demand for increasingly scarce resources, that trend won’t be playing out quarter to quarter.

Quarter to quarter, global economic conditions, the challenges of running mining operations in third-world countries, and the vagaries of the capital markets will have a much bigger impact on the fortunes of ETFs like LIT and REMX.

So if you’re betting on scarcity, recognize that you’re in it for the long haul.

 


 

At the time this article was written, the author held no positions in the securities mentioned. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.


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