For about two years now I have been following news stories and research on a small group of basic elements. On September 23rd a little story caught my eye. It seems China has put some form of embargo on all exports of a series of these materials to Japan in retaliation for Japan's refusal to release a Chinese fishing boat captain. Japan has now released the captain but the real story is what the embargo was placed on: rare earths.

What are rare earths?

Essentially rare earths are critical components for the 21st century.

They consist of 17 elements from the periodic table referred to as the lanthanides. They are usually found in powdered form as oxides.

You probably didn't study these in chemistry class and you won't see them being shipped in giant ore freighters. The market itself is very small - just over $1 billion per year.

They have quietly become essential components for our modern economy.

They are used in petrochemicals, environmental protection, clean technologies, electronics, automotive applications, optics, telecommunications, computing and defense.

They are pretty much indispensable in these areas.

No rare earths equal no TV screens, no medical imaging devices, no digital cameras, and no smart bombs.

Neodymium is used in the fins of bombs dropped in Afghanistan.

It's also found in millions of stereo speakers, disk drives and motors.

Lanthanum is used for cracking petroleum in refineries. Some estimates indicate without it we would need 15 percent more oil to generate the same yield.

Very large high-efficiency windmills require about 500 pounds of neodymium in their strong permanent magnets. Indium is an essential raw material used in a variety of electronics and industrial applications.

It's found in video screens and solar panels. Lanthanum is also used in alloys used to manufacture fuel cells and rechargeable batteries. If electric vehicles are ever going to become common, it will be only because large amounts of lanthanum enable long-term power storage. These are but a few examples.

In other words, without rare earths many high tech companies and suppliers would be out of business.

Who owns them?

The Chinese. The Chinese is the Middle East or OPEC of rare earths.

They mine about 93 percent of the world's supply of rare earth minerals and control 99 percent of the supply for some groups of these elements.

China also has the largest share of worldwide reserves at about 36 percent; the US is second with 13 percent, according to the US Geological Survey. China produced 120,000 tonnes, or 97 percent, of the world's 124,000-tonne supply last year. China's dominance does not just end with its supplies.

It also has world leading infrastructure and education. They have numerous mining operations and have trained some 1,000 to 2,000 dedicated rare earth scientists.

This gives them major control and advantage to develop many forms of technology now and in the future. China has cornered the market for rare earths and the buyers may need to begin begging for supply.

Zhang Hongjiang, director of Baotou Research Institute for Rare Earths Information Center in Mongolia, has said: "The rare earth industry is quite small scale, but the contribution to the national economy is huge...[China] regards rare earths as a strategic resource because they are widely used in high technology and new materials."

Future demand

Demand for these critical elements is exploding. In 2007 demand was only about 110,000 tonnes.

Estimates indicate demand will surge to 600,000 tonnes by 2012. 350,000 tonnes alone could be used in electric and/or hybrid vehicles.

Global demand by 2020 to 2025 could reach two million tonnes, including 1.5 million tonnes applied in electric/hybrid vehicles.

This surging demand and supply constraint can be readily seen in the escalation of some prices of materials.

Samarium, a critical element used in missile guidance motors, has tripled in price since July when China first introduced export quotas.

Some elements have actually increased more than six fold.

Clearly these components will continue to be essential for our technological future.

If the Chinese chose to shut down exports of rare earths, the world would be in trouble.

Investment and political Implications

The growing global dependence on these elements is not well appreciated by most; including many policy makers and investors.

It could be argued that the US, Europe and Japan's dependency on foreign supplies of rare earths is greater than its dependency on foreign oil.

Given rare earths critical role in various supply chains for future technologies and their role in defence technologies, numerous political and investment angles present themselves. Obviously the US military is very concerned that they are becoming almost 100 percent reliant on the Chinese for critical components that they need in their defense products.

Six months ago the Government Accounting Office, warned of the national defence problems stemming from the lack of secure supply (domestic) of rare earths. For example, China is virtually the only supplier of Yttrium that is needed in laser guided gun sights for Abrams tanks.

It also controls other elements used to silence the whoosh of Boeing helicopters blades. Clearly, the US does not want to be held hostage to another country, especially China, to supply its defence department (Sidebar:

The US was actually the main supplier of oil to the Japanese in 1930s, and the imposition of the American embargo on Japan in 1941, in an effort to curb Japanese military expansion, is sited by some historians for the reason why Japan subsequently attacked Pearl Harbor).

In 1951 US President Truman commissioned a study to "assure an adequate supply of production materials for our long-range needs".

I would not be surprised if the US did the same now. Furthermore, many Chines government officials have suggested that China move up the value-added chain in terms of manufacturing components like motors and magnets that need rare earths.

This would further solidify the Chinese manufacturing base and potentially cost jobs for those nations who currently use rare earths to develop technological components.

In a world where politicians are under pressure to create jobs, this is not likely to go unnoticed.

If China continues to restrict supply, trade wars could result. This, of course, would not help the global economy.

I don't believe this will happen, however. I actually think the investment angle is more interesting.

Obviously there is a massive supply/demand imbalance in these elements that are essential for our technological future.

Alternative supplies must be secured and developed. As a result it would not be surprising to see a surge of capital investment, exploration and research directed into this field.

In addition to China, the US, Australia, and a handful of other countries have rare earth capabilities.

The resultants rise in prices, as well as technological developments, may make exploration and R&D more attractive to other marginal producers.

For instance, Canada, Russia, Brazil, Congo, Vietnam, and India are thought to have sizable rare earth deposits. Greenland, too, may offer a large potential reserve base.

Denmark recently relinquished sovereign claim on Greenland's mineral rights, which creates fresh opportunities for private investors.

Maybe rarer than rare earths themselves, however, are the direct public investment opportunities.

The two main publicly-listed companies in this space are Molcycorp (Ticker: MCP) and Australia's Lynas (Ticker: LYSDY). Both are pre-production companies and have substantial risk. Lynas hopes to be in production by 2011 and Molycorp by 2012.

I wouldn't rush out to buy these now as the recent stories in the press have spiked interest in these names.

Over time though, the rare earth market appears to offer substantial opportunity to profit.