People in my profession, which is investments, are constantly searching for ways to make a profit. This needs no apologies. It is what we do, and it helps our clients to survive the ravages of inflation and the tax collector. At this time, one of the more promising areas of investment lies in a field that many have never thought of as an investment opportunity: strategic metals and critical materials.
For several years, the firm of which I am a general partner recommended the purchase of precious metals, especially gold, as an appreciating asset and as a hedge against inflation. Our clients who took our advice and bought gold in the 300s and 400s were quite happy when gold moved up into the 600s and 700s and briefly touched the stratospheric 800s. Since then, gold has descended to the high 400s and in our judgment is likely to go through a period of sideways price movement with a downward bias. Gold will glitter again, but in the short to medium term, there are more attractive investments.
Although much has been written about gold—its beauty, its durability, its industrial uses—in fact, it has little intrinsic value except for filling teeth and manufacturing jewelry. It holds its value over centuries for other reasons: its scarcity, its role in the world's monetary systems, and its function as a storehouse of value.
By contrast, strategic materials derive their value from their very real utility, even indispensability, in industrial applications and in national defense. Without the key strategics, we have no viable steel industry; we cannot build a modern jet engine, an oil refinery, a power-generating plant, and we cannot defend the United States militarily.
THE UN-GOLD METALS What metal appreciated 2,000 percent in the last 24 months? No, not silver. It is a metal called tantalum, which is used as an alloy to harden steel for cutting tools.
What metal at the beginning of the Iraq-Iran war moved from $770 to $1,000 and held its gains? No, not gold, although gold gained well in that same period. I refer to germanium, a metal used in trace quantities in night sights for weapons and in the light-emitting diodes of your calculators and electronic wrist watches as well as in fiber-optical applications.
What metal's price went up in one week from $19.20 a pound to $23.30 and held its gains simply because 30 Tanzanians happened to cross Zaire on their way to attack Uganda? The answer is cobalt, which we must have to manufacture jet engines. Zaire, which used to be the Belgian Congo, and its backward neighbor Zambia, together produce about 65 percent of the cobalt used by the industrial Western nations, and politically, they are accident-prone.
For many of the strategics, there are no adequate substitutes except other strategics. The materials with which we are concerned have these points in common: the United States and its allies are heavily import-dependent on them, and they are produced mainly in distant areas that are subject to political turmoil, Soviet aggression, or outright embargoes. The question arises, what would we pay for these materials if supplies were reduced or cut off?
Nation's Business, the journal of the United States Chamber of Commerce, recently observed: "The notion that whatever we need will somehow always be there has apparently lulled us into a false sense of security and could someday be shattered by a crippling resource crisis that would be and will be more destructive than the oil embargo—a cutoff of foreign supplies of critical nonfuel materials."
The United States imports more than 50 percent of its requirements in 18 strategic materials that are critical to our national defense and to the functioning of our industries. In the case of 12 key minerals, imports account for more than 80 percent of consumption.
Of greatest concern to our defense authorities are four groups of materials. Chromite and its derivatives are essential for the manufacture of stainless and other high-performance steels used in engines, industrial machinery, and armor plate. Manganese is essential in all steelmaking, while the platinum group of metals is used in telecommunications, oil refineries, chemical industries, and the control of air pollution. Cobalt is vital for high-temperature uses in jet engines and in electronics.
WHY WORRY? In 1980 the United States imported 91 percent of its chromite, 97 percent of its manganese, 93 percent of its cobalt, and 87 percent of its platinum group metals. For all of these metals, the country is heavily dependent on basic sources in southern Africa; for chromite and platinum, it draws significant supplemental supplies from its principal adversary, the Soviet Union. How long could we get that chromite and platinum from the Soviet Union if we came to a serious political confrontation with the Soviet government?
Zaire and Zambia, those political basket cases that produce most of the world's cobalt, are trying to form an OPEC-style cartel to support its price. In this they are getting direct support from the Soviet Union, which appears to be purchasing large quantities there for its aerospace industry and for its stockpiles. Those Soviet purchases from Zaire and Zambia provide those nations with much-needed foreign exchange and make them more independent of Western markets.
The lesson of OPEC, which managed effectively to corner the market in a highly strategic raw material and to commit economic extortion against the West, has not been lost on the underdeveloped but mineral-rich countries of southern Africa. We can expect to see a similar strategy attempted in other raw materials. The West's oil crisis of the 1970s may be only a prelude to supply squeezes in other raw materials right on through the 1980s.
While the United States is vulnerable to the threat of cutoffs or supply reductions, it does have a defense in its stockpiling program. Since 1946, the US government has created a strategic stockpile of 93 materials judged essential for national defense. The government's target has been to store enough of each material to meet the nation's essential defense needs for a three-year war. The program has not sought to provide for civilian industrial needs nor for those of US allies.
These stockpile goals are reasonable, but the fact is that many of the stockpiles of individual materials are far below their stated goals. In chromium metal, the stockpile goal is 10,000 tons; the inventory stands at 3,763 tons. In cobalt, the goal is 85.4 million pounds; on hand, we have 40.8 million. For titanium sponge, the goal is 131,503 tons; we have only 32,331 tons on hand. In palladium, one of the platinum group of metals so essential for refining, chemicals, and electronics, the goal is 2.5 million troy ounces; the stockpile stands at 1.3 million ounces.
To carry this point further, we must examine the quality of the materials held against that day we need them to make our weapons of war. The government admits that 60 percent of the cobalt in the stockpile is below the quality required for use in superalloys, while knowledgeable sources in private industry suggest that only 10 percent of our stockpiled cobalt could be used for its most critical purposes, in superalloys.
A Defense Department spokesman has said that the inferior quality will cause no problem because the materials could be upgraded in as little as 30 days. Rep. Jim Santini of Nevada, however, who has done a great deal of pioneering work in the field of strategic materials, responds: "That kind of thinking borders on indefensible nonsense."
What we must recognize is that we are in fact involved in a resource war that is not going to end this year or next. Jim Santini has called this war an undeclared conflict more serious than the Vietnam war ever was. William Mott, a retired rear admiral of the US Navy and another Washington-based expert on the minerals problem, says that from Moscow's viewpoint a resource war is a low-cost, low-casualty offensive, usually just below the threshold of effective response by the Western allies.
TIME FOR BUYING IN Nobody needs to be a genius to recognize that a major geopolitical shift is taking place. From the Middle East to southern Africa, the Soviets are flexing their muscles. They now control Afghanistan, wield considerable influence in Libya and Iraq, and are seeking a foothold in Iran. They intend to control the Persian Gulf by 1983 by intimidation and by the vacuuming process of bringing other countries into their vortex. On the African continent, they are not-so-subtly extending their reach through their Cuban surrogates in Ethiopia, Mozambique, and Angola and through Marxist-led guerrillas who are probing South West Africa (Namibia). A self-declared Marxist is master of Zimbabwe.
It begins to be clear why we think of strategic materials in two contexts: first, as essential elements on which the military security and economic health of the United States depend, and second, as vehicles for investment with a high probability of price appreciation over a reasonable period of time. No sane person wishes for the kind of international crisis that would create a defense-related shortage of these materials. But if such a crisis occurs, the country will be stronger for being able to draw upon reserve supplies that its forward-looking investors have accumulated to supplement the federal stockpiles.
Commercial metals generally follow an inventory accumulation cycle. This means that when economic recessions choke commercial demand for the materials, prices soften, supplies improve, and producers seek outlets. In relation to many of the strategics, we are in just such an accumulation cycle in 1981. I believe that the investment opportunity in certain of these metals exceeds the opportunity in gold, though it is still great in precious metals.
Some of the great fortunes in our industry have been made not on objective commodities—those most commonly traded in the public markets—but in more esoteric commodities. Gold's price rise from 35 to 850 was magnificent, but even higher gains have been registered in other materials. Somewhere among the 93 substances officially defined as strategic, and in some related products, lies a potential that may be just as exciting.
The shares in producing companies may be leading indicators of this market. Why has Oregon Metallurgical, a producer of titanium, moved from $5 to over $50? And why has US Antimony moved from $2 to more than $10?
METALS MECHANICS The strategy that I propose is the outright purchase of certain key strategic materials and their safe storage with the full expectation that it will be in the investors' interest and in the national interest to resell them at the prevailing market prices in three years or more. The process is simple, and the investor does not need to give up a percentage of his profits to any adviser, broker, or expert.
The major commercial markets for most of the strategics are dealer markets in London, and the London Metal Exchange (LME) has developed a tested set of procedures for having materials assayed, inventoried, and stored in ways that give protection against fraud. I recommend using a broker who observes the LME-approved procedures and safeguards established for base metals and applied to strategics.
The investor should demand and get a document confirming his purchase and showing the material purchased, the quantity bought, the price paid, and the commission paid to the broker. A warehouse receipt is essential. Under LME rules, the warehouse receipt states the amount and type of material held in the warehouse; this receipt can be issued in bearer form or as a certificate listing the name of the owner.
Further, the investor should get an assay certificate and a sampling certificate. The sampler goes to the warehouse where the materials are stored and makes a sight inspection. He weighs the material and takes a sample to the assayer, who tests for chemical properties and impurities. The cost of all this documentation is usually less than $200 for each item.
Under British law, observed in most depository areas, the responsibility of the warehouse is limited to due care; in the absence of negligence on the part of the warehouse, it is not responsible for theft. Therefore the investor should get insurance protection from Lloyds of London or some other responsible insurer. The investor should also require an annual audit by a recognized auditing firm, possibly one recommended by the dealer. An auditor will provide a letter stating that the receipts handed over to the owner of the materials are bona fide documents. Most metal brokers will negotiate these safeguards.
Where is the risk of fraud in all of this? It lies in the delivery of materials below the quality represented and in the duplication of warehouse receipts. The procedures that I have suggested will offer protection against these risks.
A MODEL METALS MIX Clearly, no one will want to buy into every one of the 93 strategic materials, any more than a private investor would be likely to buy shares in every one of the Standard and Poor 500 stocks, and some nonstockpiled materials may also be of interest. We do not recommend buying these materials for short-term trading profits. Rather, the technique that I see as most likely to yield a substantial profit is to take positions on a fully paid basis for three to five years, using no more than 10 percent to 15 percent of the investor's portfolio funds.
With these caveats and after a study of prospective uses and demand, supplies available now and expected in the future, our firm has developed a model portfolio costing in the range of $118,500, plus brokerage and documentation. This portfolio includes:
• Five metric tons of antimony at $17,650 at recent prices. The metal should be in ingots of 99.6 percent minimum purity, packed in wooden cases. Antimony is a limited-warfare metal. Alloyed with steel it makes brittle shrapnel; with lead it makes soft bullets. It is used in incendiary materials and also in flameproofing and camouflage paints. It is also heavily used in storage batteries for automobiles and military vehicles and to replace nickel-cadmium batteries because cadmium has been found to be extremely carcinogenic.
• One metric ton of chromium, trading recently at $9,350, delivered in lumps of 99 percent minimum purity packed in steel drums. Chromium is an essential ingredient of stainless and other high-performance steels. Most of the Western world's supply comes from South Africa and Zimbabwe.
• 250 kilos of cobalt delivered in broken cathodes of 99.6 percent minimum purity, packed in steel drums. At recent prices, this will be $13,000.
• 20 kilos of germanium at 99.9 percent minimum purity, costing approximately $21,000. This is the metal that recently moved from $770 to $1,000 a kilo. Above-ground supply in the world is small, around 40 metric tons, and production so limited that it is not beyond imagination that the market could be cornered, and just such an attempt may be in progress.
• 10 metric tons of electro-manganese, delivered in flakes of 99.95 percent minimum purity packed in steel drums and costing about $16,800. Manganese is an essential element in steelmaking, and the United States is 97 percent dependent on imports, mainly from southern Africa. The Soviet Union, once considered to be self-sufficient in manganese, is now buying in world markets.
• 500 kilos of titanium sponge, the aerospace metal, of 99.6 percent minimum purity and packed in drums, approximately $10,800.
• 20 troy ounces of rhodium, one of the platinum metals, 99.9 percent pure, and worth, at recent prices, approximately $13,500.
• 50 kilos of indium, a metal used in electronics and solar cell technology, in ingot form of 99.99 percent minimum purity, packed in drums. At recent prices, $16,250.
The prices and market movements of these materials can be followed by reading American Metal Market, Metals Week, and the Metal Bulletin, or on the Reuters money wire, by keying the code LMEC. The financial and general press is also awakening to the significance of this field of investment and is devoting more coverage to it.
ENCOURAGING INVESTMENT The new Reagan administration, I believe, will take steps to improve the administration of the national stockpile and to speed up procurement of some of the materials in which the stockpile is dangerously deficient. The administration understands the need to reduce the nation's vulnerability to OPEC-type cartels and the politically inspired disruption of sources. At the same time, the administration faces serious financial constraints on its ability to invest large sums of public money in stockpiling.
It seems to me that the time has come for the development of some innovative solutions to this pervasive problem, partly because our national security is at risk but also because our principal allies, lacking stockpiles of their own, are even more vulnerable to supply interruption than is the United States. We should also consider, of course, the dangerous economic impact on our economy of a shortage of such materials as manganese, chromium, cobalt, and the platinum metals. One solution is to involve the private sector in meeting the problem. To that end, I believe the government should offer incentives and safeguards to private investors and industrial consumers willing to add to the nation's available resources in strategic materials.
The government should apply favorable tax treatment through fast writeoffs of the capital costs of building private stockpiles, while such costs as insurance and documentation should be treated as ordinary costs of doing business. Industrial users and potential stockpilers of strategic materials should be entitled to investment tax credits on their investments, just as industries in nonstrategic areas are encouraged through tax preferences to invest in payroll-generating productive enterprises. I also believe it is reasonable to write provisions for favorable capitals gains treatment for profits in stockpiled materials. Bonds could be floated for the purchase of strategics, secured by the warehoused materials, and it would make sense to make the coupons of these bonds tax-exempt. Clearly, encouraging private investment in strategic materials would relieve the government of some of the fiscal and inflationary pressures resulting from a solution relying solely on government financing and initiative.
The year 1981 is a period of recession in many parts of the world, and prices of many of the materials we need are at cyclically low levels, a situation made to order for the start of programs such as I have suggested. A year from now, or farther in the future, conditions may be far less favorable.
James Sinclair is the president of Sinclair Securities, Inc., and publishes a weekly economic newsletter. This article is adapted from Mr. Sinclair's presentation at the November 1980 meeting of the National Committee for Monetary Reform.