Mine the Metals Market

Exploit the profits that lie in indium, rhenium, germanium, and other strategic metals

The prospect appears likely that in the years ahead the world will face shortages in some of the most vital raw materials. This risk threatens to cause a seismic shift in world power patterns. The industrial nations will have to give a higher priority than in the past to securing sources of key materials and protecting the sea lanes by which these commodities move to market. Producers and exporters of strategic metals will enjoy an unmatched opportunity to use their resources as geopolitical levers. Whether they will possess the political and diplomatic skills to profit from their opportunity without being drawn into the new Communist colonial empire is still an open question.

At the heart of the problem lies the Soviet Union—rich in oil and other strategic minerals, its industries backward and inefficient, its agriculture chaotic and vulnerable to the vagaries of a brutal climate. To generate funds for its essential imports, the Soviet Union sells oil, gold, and a variety of solid minerals, but it conceals its purposes behind a security curtain and rarely moves in the direction that simple commercial considerations would suggest. Strategic rather than economic goals appear to dominate its behavior, and thus for reasons often unclear to the West, Moscow sells or withholds its strategic minerals in unpredictable patterns. The Soviet Union is not a reliable trading partner, and the West has been forced to develop alternate sources, even for minerals that the Soviets are believed to produce in abundance.

In the long reach of history, access to raw materials and trading routes ("freedom of the seas") has been a classic root cause of conflict among nations, and in the ongoing rivalry between East and West this pattern could play itself out again. Shortages of food and limited economic development in the Soviet Union or the Third World, or denial of essential resources to the West, could surely create international tensions capable of slipping out of control.

It is a normal role of private investors and their professional advisors to try to anticipate geopolitical trends and to act on their interpretation of events. In a world where lack of manganese could shut down whole steel industries, where lack of cobalt could silence a nation's jet fleets and lack of platinum severely impair chemical and refining industries, the potential for international conflict over control of key resources cannot be dismissed.

While sources, supply routes, and price patterns are well established for the major industrial metals, the changing technology of modern industry is constantly affecting the markets for the more obscure "minor metals." These may gain considerable importance even though their total world production is only a few thousand kilograms a year. New developments in solar power generation, electronics, oil refining, and weapons technology have created sharp increases in demand and price for such metals as gallium, germanium, indium, and rhenium. The alert investor is better situated than an inertia-ridden government agency to respond to changing markets and prices.

As trading practices develop and mature, the efficiency and liquidity of markets increases. New market operators enter the field. Information becomes more available and more accessible. The Reuters Money Wire system, for example, offers its subscribers up-to-the-minute market information on a wide range of "minor metals," accessible on a cathode-ray tube upon keying the proper codes. Reuters tracks 15–20 of the commonly traded metals.

A growing interest in the investment potential of strategic metals has led a number of nationally known brokerage firms to offer specialized services in the buying and selling of these commodities. When E.F. Hutton speaks about strategic metals, more and more people are listening. Bache & Co., another nationally known brokerage firm with a renowned commodities trading department, has also moved into the field. Other firms, too, are offering various services, including Strategic Metals and Critical Materials, Inc., a subsidiary of the New York-based Sinclair Group Companies (headed by one of the authors of this article).

The current state of the markets in critical and strategic materials might be compared with the state of the markets in over-the-counter securities before the development of automated quote systems for market-making in NASDAQ-listed stocks and inactively traded securities. Public markets for critical and strategic materials are expanding as supply, industrial demand, and trading volume increase. These new markets enhance an investor's ability to enter the market with the assurance of being able to buy and sell at prices reasonably reflecting current conditions in an efficient market.

Along with a number of thoroughly reputable and well-financed investment firms, the new field of strategic-metals trading has attracted a quota of unscrupulous operators, more intent on turning a quick profit for themselves than in educating their customers or building a long-term business relationship with them. State and federal securities regulators have been alerted to some of the sharp practices and shady operators entering the field and are on their trail. But to paraphrase the slogan of a well-known discount clothier, an educated consumer is the best customer, in strategic metals as in many other areas. The investor's best protection lies in his own understanding of the field and in being alert to the possible pitfalls.

An investor should understand that no broker can legitimately "guarantee" a profit to the buyer, and any smooth-talking telephone caller offering a sure thing should be heard with the utmost skepticism. Second, the investor should be aware that except for the precious metals platinum, silver, and copper, none of the strategic metals is traded in the United States in the form of futures contracts. The investor should expect to buy and pay fully for materials he acquires.

Other traps for the unwary are the offering of metals at unrealistically high prices in terms of the market or the offering of commercial grade and therefore difficult to resell. A few tenths of 1 percent in the purity of cobalt and some other metals will make a substantial difference in the market value of the product, so the offering of low-grade material at high-grade prices is, unfortunately, one of the pitfalls to watch for. Beyond that, any salesman exerting undue pressure to "buy now before the price goes up" may be trying to coerce his customer into acting with insufficient information. Use of any of these high-pressure tactics, especially by a telephone caller whom you have never heard of, should serve as a red flag of warning.

It is an axiom in investing that the time to buy is when buyers are scarce, and the time to sell is when others are clamoring to buy. This basic truth is as valid in strategic investment as in any others.

The early 1980s has been a period of worldwide industrial recession, and the prices of many industrial materials, including strategic metals, have fallen below their long-term trend lines. This has been true for cobalt, chromium, manganese, platinum, and many other metals. This suggests that a long-term buying opportunity prevails for investors willing to apply their intelligence and to commit their funds to a form of investment still unfamiliar to many. This favorable period for investment may not last much longer. The time to sell will arrive when tensions rise, materials shortages develop or threaten, and buyers actively bid for available supplies of commodities that the prudent and farsighted have purchased and stored earlier.

An investor who takes into account long-term market cycles, who follows and interprets geopolitical developments, who enters the market with professional care and exits under the guidance of intelligence rather than emotion, may enjoy substantial long-term profits for his foresight. He may also help his country to weather the materials crises that almost surely lie ahead.

Since 1949, when President Truman launched the postwar stockpile program, successive administrations of both parties have concurred in the building of a stockpile of strategic materials for use in a national emergency. In 1982, the stockpile met only about 50 percent of its legislated goals.

The Reagan administration clearly would like to expand the stockpile but surely will be constrained by budgetary considerations from making large new commitments to stockpile expansion. With its philosophical commitment to free-market principles, the administration might well conclude that the national interest will be served by encouraging private investors to buy and hold strategic materials so that they would be available in a national emergency.

One strategy would be for the federal government to offer tax incentives to encourage industry and private investors to build nongovernment stockpiles of critical materials. For industry, such incentives might include substantial acceleration of depreciation allowances and investment tax credits. Together these two provisions could offer private, mineral-consuming industries a powerful incentive to expand their inventories for future consumption.

Application of graduated tax incentives could provide benefits for retention of supplies to cover requirements for several years—a form of accumulation quite difficult when interest rates are sky-high. Corporations could be encouraged to finance these inventories through the issuance of bonds secured by the mineral inventories, and enjoying tax benefits similar to those provided by municipal bonds. These corporate bonds would be very attractive to investors because of their tax incentives and their mineral collateral and would therefore command lower coupon rates, solving the problem of money availability and cost.

Tax benefits could also be made available to the private investor. Those benefits could take the form of lower taxes on capital on minerals in which the US government has stockpile requirements. Investors' inventory should be subject to depreciation allowances.

To qualify for these benefits, mineral stockpiles would have to be stored in the taxpayer's country of citizenship, whether the United States or one of its free-world allies. Investors who chose to take advantage of these tax incentives would be entering into an explicit or implicit contractual relationship with the government, giving the government the option of purchasing the stored materials in time of emergency. The regulations setting up this relationship should clearly define the emergency in which the government could exercise the option to purchase the materials, and it should clearly set forth the method and timing of payment. Further tax incentives should be applied in case of a national emergency and the purchase of private stockpiles.

The most legitimate purpose of tax incentives and tax shelters is to stimulate investment in areas of industry in which risk and national need exist but in which a capital base is lacking or deficient. During a recession, demand so created should not overly distort markets. Can there be a more legitimate application of the tax-shelter principle than maintaining the independence of the free world or preventing mass unemployment in industries that would be severely damaged by a minerals embargo?

The authors believe that to encourage private stockpiling would clearly enhance national security at minimal cost to the Treasury in forgone tax receipts. And they would have far less impact on inflation than would expanding the federal deficit to finance government stockpiles with borrowed money.

Whether on not the government encourages such investment, however, vital raw materials present an outstanding investment opportunity. And with the markets in such materials increasingly efficient and liquid, investing in strategic metals is now within reach of ordinary investors.

James Sinclair, founder of Sinclair Securities, publishes a biweekly investment commentary. Robert Parker is a journalist. This article is adapted, by permission of the authors, from their recently published book, The Strategic Metals War.