While China produces nearly all the world's rare earths, it has only a third of the reserves. Early on, the Chinese government at the highest levels recognized the strategic importance of rare earths, and used various methods to support the domestic industry. The former premier, Deng Xiaoping is famously quoted as saying that "The Middle East has oil, and China has rare earths." They achieved their dominance through poor environmental stewardship, trade intervention, and the fact that the largest source of rare earths is not a rare earth mine, but rather an iron mine that produces rare earths as a by-product.

The effect has been that, until now, producing elsewhere has not been feasible. However, demand has been growing within China, and so export restrictions have been put in place. As a result, prices of the rare earths have fluctuated wildly, and the world is waking up to the fact that dependence on a single source of economically critical materials is a dangerous situation. Currently, no other country benefits as much as China, which has created tens of thousands of rare earth scientists.

Eoin Treacy's view The Chinese restriction of rare earths metal supply as part of their attempts to influence high technology companies to choose to locate their has backfired somewhat. More countries are now building production capacity as a strategic priority. In addition, the high prices that from this policy have had the normal effect on the incentive to produce more. Production quotas have been widely abused, illegal mining remains a serious issue and smuggling has increased. The Chinese have so far failed to police these issues and the result is that rare earth metals prices have fallen quite considerably.

Most related shares trended lower through most of 2011 and have lost momentum over the last few months. Alkane Resources, Great Western Minerals and Neo Material Technologies have had perhaps the best rallies of companies listed outside China but will need to hold above their respective lows on the current pullback to bolster the recovery hypothesis.

Chinese listed rare earth related shares have outperformed. China Rare Earth Metals broke out of a short-term base one month ago and rallied to HK$2.25 by last week. It pulled back sharply yesterday and will need to find support above or in the region of HK1.70 if the recovery hypothesis is to be given credence.

Inner Mongolia Baotou Steel Rare Earth Hi-Tech bounced impressively from early January. It has become overextended in the short term and pulled back somewhat this week. A sustained move below CNY47 would be required to question recovery potential.