How to Invest in Critical Minerals and Rare Earths | Steve Schoffstall and Jimmy Connor

Key Concepts

• Critical Materials: Metals and minerals deemed vital by governments for energy security, national security, and economic strength.
• Rare Earth Elements (REEs): A group of 17 metallic elements crucial for modern technologies, including EVs, wind turbines, and defense systems.
• Supply Chain Vulnerabilities: The realization by countries that their access to critical materials is often controlled by a limited number of global suppliers, particularly China.
• Geopolitical Influence: The significant role of international relations and trade dynamics in the sourcing and production of critical minerals.
• Energy Transition: The shift towards renewable energy sources and electrification, which drives demand for specific critical materials.
• Exchange Traded Funds (ETFs): Investment vehicles that allow investors to gain diversified exposure to a basket of assets, in this case, critical minerals and metals.
• Pure Play Approach: An investment strategy that focuses on companies deriving the majority of their revenue from a specific commodity or sector.
• Active vs. Passive Management: The debate between investing in index-tracking funds (passive) versus funds managed by professionals who actively select investments (active).
• Supply Deficit: A market condition where demand for a commodity exceeds its available supply.
• Ore Grades: The concentration of a valuable mineral within a rock formation, which impacts the cost and feasibility of extraction.

Critical Minerals and the Geopolitical Landscape

The discussion highlights a significant global push, particularly in the US, to acquire rare earth elements and other critical minerals. This initiative is driven by governments recognizing the vital importance of these materials for energy security, national security, and economic stability. Critical materials are broadly categorized by their role in the energy lifecycle: generation (e.g., rare earths, silver, uranium), transmission (e.g., copper), and storage (e.g., lithium, cobalt, graphite, manganese, nickel).

The geopolitical landscape has been a major catalyst for this focus. Over the past four to five years, countries have become acutely aware that supply chains for many critical materials are outside their control. China's dominant position in the mining and processing of many of these resources, especially rare earths, has led to a strategic imperative for other nations to increase domestic supply and encourage local mining and refining.

China's Dominance in Rare Earths and Processing

China has spent the last two to three decades building a robust global supply chain for critical materials. While they mine some materials domestically, they also import significant quantities from other regions like Africa and Indonesia for refining. Rare earth elements are particularly in the spotlight due to their essential role in technologies such as electric vehicles (EVs), wind turbines, AI data centers, and crucially, defense systems (e.g., missile guidance systems). China's leverage in refining and production has been used in trade negotiations, prompting the US and allied countries (Australia, Canada) to collaborate on securing these supply chains.

Government and Private Sector Investment Initiatives

In response to these supply chain concerns, governments and private entities are making substantial investments.

• US Government Equity Investments: The US government has taken equity stakes in several critical mineral companies. Examples include a 10% stake in MP Materials (a rare earth miner) and investments in Trilogy Metals (copper project) and Lithium Americas (US assets).
• Stockpiling Efforts: Australia is considering building stockpiles of critical materials, potentially allowing other countries to invest. The US Pentagon announced a $1 billion initiative to build a stockpile of critical materials, with rare earths being a significant component.
• JP Morgan Initiative: JP Morgan is launching a $1.5 trillion security and resiliency initiative, including venture funding and direct investments of up to $10 billion into companies focused on critical minerals and other key sectors. This initiative targets 27 areas, with a focus on mining, production, and refining capabilities.
• Hyperscalers and Nuclear Energy: Large data centers associated with AI are increasingly turning to uranium and nuclear energy for reliable baseload power, driven by clean energy mandates and high electricity needs.

Nuclear Energy and Uranium Supply Concerns

Nuclear energy plays a significant role in the US, providing 20% of its electricity. However, the US consumes 45-50 million pounds of uranium annually while producing very little. This reliance on foreign sources, particularly Canada with its large uranium reserves, is a critical concern. Global uranium production is projected to be around 170-180 million pounds by 2050. With the US aiming to quadruple its nuclear energy capacity by then, domestic demand could outstrip global production.

Impending Supply and Demand Imbalances

A recurring theme across many critical materials is an impending supply and demand imbalance. Some metals, like copper, have already entered or are expected to enter a supply deficit this year. Uranium and copper are projected to face prolonged, decades-long deficits. This outlook is driving governments and private companies to incentivize production to meet growing demand and address supply constraints.

Sprott's Investment Products for Critical Minerals and Metals

Steve, representing Sprott, discusses several investment products designed to provide investors with exposure to critical minerals and metals.

Sprott Critical Materials ETF (SETM)

• Focus: Provides broad access to a group of nine critical materials, including battery metals, uranium, rare earths, silver, and copper.
• Strategy: Employs a "pure play" approach, requiring companies to derive at least 50% of their revenue from mining one of these nine critical materials.
• Unique Features: Includes uranium exposure, which is often excluded from other diversified critical materials ETFs.
• Asset Allocation (approximate):
  • Uranium equities: 25%
  • Lithium: 20%
  • Copper: 19%
  • Rare earths: 17-18%
• Ticker: SETM
• Listing: Primarily on NASDAQ, available across the US.

Sprott Active Metals and Miners ETF (MEL)

• Focus: A more recent ETF (launched September) with a broader mandate beyond just critical materials, aiming to capture opportunities in metals important for infrastructure buildout and economic growth.
• Strategy: Active management, leveraging Sprott's decades of experience in metals and mining. The investment team conducts extensive research, including over 200 management meetings and site visits annually.
• Exposure: Includes critical materials, but also steel, platinum, palladium, aluminum, zinc, gold, and iron ore.
• Rationale for Active Management: The mining sector is complex, with a wide dispersion in returns. Active management can identify outperforming companies, as the top 25% of mining equities often drive significant returns.
• Ticker: MEL
• Listing: Available on NASDAQ.

Sprott Copper Miners ETF (COP and COPJ)

• Focus: Targeted investment in copper mining companies.
• COP (All-Cap):
  • Strategy: Pure play, all-cap exposure to copper miners.
  • Unique Feature: Includes approximately 5% allocation to physical copper.
  • Market Position: The only pure play, all-cap copper ETF and the only one offering physical copper holdings.
  • Rationale: Addresses the fact that many large copper producers are not predominantly copper miners, ensuring focused exposure.
• COPJ (Junior Copper Miners):
  • Strategy: Pure play strategy focused on junior copper mining companies involved in development and exploration.
  • Unique Feature: No physical component.
  • Market Position: The only junior copper mining ETF available to US investors.
• Copper Market Dynamics: Copper is experiencing bottlenecks, such as the extended shutdown of the Grasberg mine (second largest in the world) due to a landslide, expected to last until 2027. This has led to about a 5% disruption in copper production. Declining ore grades and a lack of major new discoveries make increasing production challenging.

Sprott Lithium Miners ETF (LITP)

• Focus: Pure play exposure to lithium mining companies.
• Strategy: Pure play, targeting companies primarily involved in lithium mining.
• Unique Feature: The first and most direct way to gain pure play lithium miner exposure from Sprott's lineup.
• SETM Inclusion: SETM also has a significant allocation to lithium (around 20%).
• Ticker: LITP
• Listing: NASDAQ.
• Lithium Market Dynamics: The lithium market has been volatile, influenced by China's dominance in production and refining. Falling prices have made it difficult for miners to invest in new production. Government intervention, such as US equity stakes in companies like Lithium Americas and potential price floors, aims to stabilize the market and encourage investment. Despite short-term oversupply, the long-term outlook for lithium remains favorable due to continued EV adoption globally.

Electrification and the Demand for Critical Materials

The transition to electrification significantly drives demand for critical materials:

• Copper: Essential for building out electricity grids and charging infrastructure. A traditional car uses about 50 lbs of copper, a hybrid 80 lbs, and an EV can use 150 lbs or more. Copper is also used in EV chargers due to its conductivity.
• Lithium: The primary component in EV batteries.
• Rare Earths: Used in the magnets within EV motors.
• Steel and Aluminum: Required for infrastructure buildout, including charging stations and transmission lines.

Challenges in EV Adoption and Infrastructure

While EV adoption is growing globally, challenges remain, particularly in regions like North America:

• Cold Weather Performance: EV batteries can lose 20-30% of their charge in cold weather, impacting practicality in regions like Toronto.
• Infrastructure Gaps: The availability of charging infrastructure is a significant barrier for long-distance travel.
• Hybrid Vehicles: Hybrid vehicles are seen as a more practical intermediate step for some markets, still requiring significant battery capabilities and thus demand for lithium.

Conclusion and Further Information

The discussion underscores the critical importance of rare earth elements and other critical minerals in the global economy, driven by energy transition and national security concerns. Geopolitical factors, particularly China's influence, are reshaping supply chains, leading to increased government and private sector investment. Sprott offers a range of ETFs (SETM, MEL, COP, COPJ, LITP) designed to provide investors with diversified or targeted exposure to these vital commodities and the companies that mine them. Investors are advised to expect volatility in this sector due to ongoing structural shifts.

For more information on Sprott's products and research, interested parties can visit sprottetfs.com, which features detailed information on strategies, an insights page with research and thought leadership, and regular updates on the metals and minerals markets.