The west moves to weaken China’s hold

Key Takeaways China’s dominance in critical minerals poses risks to the West’s manufacturing base and national security, highlighting the need for onshoring and friend-shoring energy transition supply chains. Western countries are forming strategic industrial policies to increase domestic sourcing and manufacturing capabilities and reduce reliance on imports. These methods include subsidies, tax credits and trade alignment measures. The scarcity and importance of critical minerals for the energy transition underscore the need for collaborative efforts, strategic partnerships and international agreements to ensure fair access and sustainable practices. Inflation has proven to be stickier than expected. The emerging U.S. industrial policy, which is driven by national security concerns and therefore relatively price-insensitive, will add to long-term inflationary pressures. Metals markets were mixed in May. Lithium rebounded on restocking and a pickup in electric vehicle (EV) sales, while copper and nickel continued to fall due to concerns regarding China’s economic recovery and U.S. monetary policy. May in Review The Nasdaq Sprott Energy Transition Index fell 4.66% in May to close the month at 879.27. The Index remains in a broad consolidation trade range (see Figure 1). Lithium and lithium miners staged a sharp rebound rally, but copper and copper miners were weighed down by disappointing data from China, ongoing global growth concerns and the U.S. debt ceiling drama. China’s economy was expected to rebound following the end of its zero-COVID policy in December and the completion of its regulatory reform this year, but signs of economic recovery are now limited, particularly within China’s industrial sector. Metals traders that had built inventory in anticipation of a China rebound have been destocking aggressively, putting downward pressure on the prices of most metals commodities. Lithium prices rebounded in May as customers resumed restocking their supply chains. The month also saw more merger and acquisition (M&A) activity as Allkem (ASX|TSX: AKE ) and Livent (NYSE: LTHM) announced a merger of equals to create a $10 billion market-cap lithium miner. 16 Industry leader SQM (NYSE: SQM) expects lithium demand to grow at least 20% this year and sales volume will recover despite China’s uneven economic recovery. At the same time, the broader equity markets continued to display unusual activity. In early March, signs of a slowing economy led to expectations of cooling inflation and the end of Federal Reserve (Fed) tightening. This sparked a rally in long-duration assets, especially mega-cap technology stocks. Near the end of May, a dot-com-like frenzy occurred in AI (artificial intelligence)-related equities, further accelerating and narrowing market breadth to a half-dozen stocks. Figure 1. Nasdaq Sprott Energy Transition Index Continues to Consolidate in May (2019-2023) Source: Bloomberg. Nasdaq Sprott Energy Transition Materials Index (2018-2023). Data as of 6/01/2023. Moving average convergence/divergence is a trend-following momentum indicator that shows the relationship between two exponential moving averages (EMAs), calculated by subtracting the 26-period EMA from the 12-period EMA. Included for illustrative purposes only. Past performance is no guarantee of future results. Loosening China’s Grip on Strategic Minerals The last decade of globalization saw commodity oversupply, minimizing supply disruptions and emphasizing financial-macroeconomic relationships over physical market fundamentals. In the West, ESG investing limited investment in carbon-intensive sectors, resulting in lower reinvestment ratios. Growth in resource commodity production was nominal, leaving the East to develop its own metals markets. Following a decade or more of below-expected reserve replacement in the West, there is still a lack of CAPEX in mining and metals required for the energy transition. This has created long lead times and potential supply shortages in energy transition metals. China’s dominance in mining and processing strategic energy transition materials is a vulnerability for Western countries. The concern is that China could restrict the supply of critical minerals, such as lithium and rare-earth elements, for commercial advantage or as leverage in political or trade disputes. A disruption in the China-controlled supply chain could lead to shortages and hamper civilian and defense manufacturing in the U.S. and other Western countries. In addition, long and fragile supply chains have proven to be brittle and risky. Hence, efforts are underway in the West to develop non-China-based alternative sources or substitutes, as illustrated by recent developments in U.S. industrial policy. U.S. Energy Transition Industrial Policy Takes Shape The Inflation Reduction Act (IRA) of 2022 and the Infrastructure and Investment Jobs Act (IIJA) of 2021 form the current basis for U.S. industrial policy for clean energy. This policy calls for targeted public investment aimed at unlocking opportunities to “crowd in” the private sector in order to build out U.S. capacity for […]

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