The West Moves to Weaken China's Hold

Theme and Background

This chapter focuses on the strategic risks posed to Western manufacturing and national security by China's dominance in critical minerals (lithium, rare earths, etc.), and analyzes the emerging energy transition industrial policies in the US and the West. The report notes that globalization over the past decade has led to an oversupply of commodities, while Western capital expenditure in the mining sector has been constrained by ESG investment restrictions. In contrast, China has come to dominate the supply chain for critical minerals, making this a core source of Western supply chain vulnerability.

Core Thesis

The author's central judgment is that China's dominance in the extraction and processing of critical minerals represents a strategic vulnerability for Western nations, as China could restrict supply for commercial or political reasons. Consequently, the West must restructure its energy transition supply chain through "onshoring" and "friend-shoring." The report argues that the emerging US industrial policy (based on the IRA and IIJA) differs markedly from other Western countries in three respects: scale, protectionism, and trade coordination. Moreover, this price-insensitive industrial policy, driven by national security concerns, will exacerbate long-term inflationary pressures.

Counter-intuitive / Consensus-defying judgments:

• Despite market expectations for a post-pandemic recovery in China, actual signs of economic recovery are limited, with the industrial sector particularly weak. This has led metal traders to significantly destock, putting downward pressure on most metal prices.
• Lithium prices rebounded in May, but the author views this more as a short-term phenomenon driven by restocking and a recovery in EV sales, rather than a fundamental improvement in demand.
• US industrial policy may ultimately lead to inflation persistence exceeding expectations, as its core driver is national security rather than cost efficiency.

Key Arguments and Data

1. Data on China's Dominance:

• Western capital expenditure in mining and metals over the past decade has been insufficient, leading to lower-than-expected reserve replacement rates for metals needed in the energy transition, creating a long-term supply gap.
• China dominates the processing stage for critical minerals like lithium and rare earths, leaving the West with few alternative sources.

2. Specific Provisions of US Industrial Policy:

• Scale: The IRA and IIJA are expected to provide approximately $1 trillion in public funds to the private sector over 10 years, including open-ended subsidies and tax credits. However, the author believes the actual figure will be higher, as tax incentives are uncapped and new initiatives may emerge.
• Protectionism: From 2023, at least 40% of the value of critical minerals in an EV must come from the US or a country with a US Free Trade Agreement (FTA); this percentage increases by 10% annually, reaching 100% by 2029. From 2025, any critical minerals extracted or processed by a "Foreign Entity of Concern" (including China and Russia) will be ineligible for tax credits.
• Trade Coordination: The policy aims to build supply chains with strategic partners. For example, Argentina (a rapidly growing lithium producer) currently has no FTA with the US and is lobbying for an exemption.

3. Historical Analogies:

• The author compares the current industrial policy to the 1956 Federal-Aid Highway Act (which covered 90% of construction costs) and the 1862/1864 Pacific Railroad Acts (which provided federal support through land grants, loans, and bond purchases), arguing these historical precedents laid the foundation for private investment.
• This contrasts with the supply-side economics popular after the 1980s (where government investment was unpopular), which led to the path of globalization, offshoring, and China-dominated supply chains.

4. Market Performance Data:

• The Nasdaq Sprott Energy Transition Materials Index fell 4.66% in May, closing at 879.27 points, remaining in a wide consolidation range.
• Lithium prices rebounded, while copper and nickel continued to decline due to concerns over China's recovery and US monetary policy.
• M&A activity occurred in May: Allkem and Livent announced a merger of equals, creating a lithium miner with a $10 billion market capitalization.
• SQM expects lithium demand to grow at least 20% annually.

Companies/Assets Involved

Company/Asset	Role	Key Data	Bullish/Bearish
Allkem (ASX: AKE)	Lithium miner	Merging with Livent to create a $10B lithium miner	Neutral (merger event)
Livent (NYSE: LTHM)	Lithium miner	Merging with Allkem in a merger of equals	Neutral (merger event)
SQM (NYSE: SQM)	Lithium industry leader	Expects lithium demand to grow at least 20% annually, sales to recover	Bullish (demand growth expectations)
China-related entities (not specifically named)	Dominant in critical mineral supply chain	Controls processing of lithium, rare earths, etc.	Bearish (geopolitical risk)
Argentine lithium producers	Emerging lithium supply country	Lobbying for US FTA exemption	Neutral (policy uncertainty)

Investment Implications

• Long-term bullish on beneficiaries of Western critical mineral supply chain onshoring: US industrial policy (IRA/IIJA) will drive the buildout of domestic mining, processing, and manufacturing capacity. Related companies (e.g., lithium, rare earth, and copper miners) may receive subsidies and tax credits. However, investors should monitor the pace of policy implementation and progress in trade agreement negotiations.
• Beware of assets exposed to Chinese supply chain risk: Any Western company reliant on Chinese processing or procurement of critical minerals may face the loss of tax credit eligibility after 2025. Investors should assess their portfolios' exposure to the Chinese supply chain.
• Inflation persistence may exceed expectations: The US national security-driven industrial policy is price-insensitive and will push up long-term inflation. This pressures interest-rate-sensitive assets (e.g., growth stocks, long-duration bonds), while real assets (e.g., mining stocks, commodities) may benefit.
• Short-term focus on the sustainability of the lithium price rebound: The May lithium price rebound was driven by restocking and a recovery in EV sales, but China's weak industrial recovery and destocking pressures persist. Investors need to distinguish between short-term trading opportunities and long-term supply-demand fundamentals.

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Theme and Background

This chapter focuses on the policy responses of the United States and the European Union regarding the supply chain of critical minerals (especially battery metals), and delves into the structural impact of the energy transition itself on inflation. The report points out that although U.S. battery capacity is expanding, upstream mineral supply remains a bottleneck, while the EU is reducing its dependence on China through legislation and the establishment of a "club" model.

Core Viewpoint

The author's core judgment is: The energy transition is inherently inflationary, and the era of low inflation driven by globalization, low-cost labor, and technology over the past few decades has ended. Protectionist, national security-first industrial policies will lead to higher fixed costs and sustained price pressures. The report argues that inflation will be more persistent than the market expects and may push up the natural rate of interest (r*).

Counter-Intuitive Judgment:

• Federal Reserve rate hikes may be ineffective in curbing industrial investments driven by national security (such as reshoring, energy transition, and armament), as these investments are insensitive to interest rates.
• The period from 2004 to 2008, when China acted as a low-cost manufacturing country suppressing inflation, is viewed by the author as an "anomaly" rather than a "new normal."

Key Arguments and Data

1. U.S. Policy and Bottlenecks:

• The U.S. provides massive incentives through the Inflation Reduction Act (IRA) and the Defense Production Act (DPA), but battery metal supply remains a bottleneck. Automakers have already invested directly in mines.
• The author expects a future combination of "offtake agreements plus pricing mechanisms" to smooth short-term price cycle fluctuations, and speculates that the U.S. may establish a strategic metal reserve similar to the "Strategic Petroleum Reserve."

2. EU Policy Targets (2030):

• Domestic extraction to meet at least 10% of strategic raw material demand.
• Domestic refining and processing to meet 40% of metal consumption.
• Imports from a single non-EU country shall not exceed 65% of total consumption.

3. Structural Drivers of Inflation:

• Trade patterns shifting from globalization to more expensive "nearshoring/friend-shoring."
• Industrial policies emphasizing security and redundancy, leading to higher fixed costs.
• Labor reshoring to higher-cost regions, compounded by labor shortages from the retirement of the "Baby Boomer" generation and the smaller size of "Generation Z."
• Technology (historically a deflationary force) facing more regulatory and data localization restrictions.

4. Historical Correlation Between Inflation and Commodity Prices:

• The report cites Figure 2 (data from 1975-2023), showing a long-term high correlation between inflation (CPI) and the Bloomberg Commodity Index, with a rolling 30-month correlation coefficient close to 1.0.
• The temporary decoupling during 2004-2008 is explained by China's low-cost exports offsetting the inflationary pressure from its own commodity demand.

Companies/Assets Involved

Company/Asset	Role and Key Data	Bullish/Bearish
Livent & Allkem	Two Argentine lithium producers announced a $10.6 billion merger, forming the world's third-largest lithium company.	Bullish (signal of industry consolidation)
SQM	The report does not provide specific data in this chapter, but earlier text mentions the company expects lithium demand to grow at least 20% annually.	Bullish (demand growth)
U.S./EU Policy	IRA, DPA, and the EU's Critical Raw Materials Act are seen as key policy drivers.	Bullish (policy support)

Investment Implications

1. Focus on Asset Allocation Changes Driven by Inflation Stickiness: The report implies that long-term inflation will push up the natural rate of interest, and traditional fixed-income assets may face sustained pressure. The value of commodities (especially critical minerals) as inflation hedges becomes prominent.

2. Upstream Mineral Investment Opportunities: The battery metal supply bottleneck is a clear investment theme. Policy support (IRA, EU legislation) and direct investment from downstream automakers will improve the financing environment for mining projects, but short-term price volatility should be watched.

3. Regional Supply Chain Premium: The "friend-shoring" and localization of production promoted by the U.S. and EU will provide miners operating in North America, the EU, and countries with free trade agreements with the U.S. (such as Argentina, which is seeking an exemption) with a structural competitive advantage.

4. Beware of Policy Risks: Protectionist clauses in the IRA could lead to trade friction between the U.S. and Europe, affecting the U.S. market access of European manufacturers. Investors need to monitor the outcomes of subsidy policy competition among countries.

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Theme and Background

This chapter focuses on the market performance of key minerals (lithium, copper, nickel) in May 2023, analyzing the driving factors behind the price trends of each metal. The report points out that lithium prices experienced a strong rebound due to restocking and direct equity investments by electric vehicle (EV) companies, while copper and nickel continued to decline, weighed down by weak Chinese economic data and expectations of U.S. interest rate hikes.

Core Views

The report argues that the current metal market exhibits a clear divergence: the supply-demand fundamentals for lithium have improved due to downstream restocking and M&A activity, while copper and nickel are suppressed by short-term cyclical macroeconomic factors, though their long-term structural bullish logic remains intact. A counterintuitive judgment is that despite weak Chinese data, copper inventories are extremely low with a clear future supply gap, and the nickel price decline is more of a short-term trading shock than a deterioration in fundamentals.

Key Arguments and Data

Lithium:

• Lithium prices rebounded sharply by 62.88% in May (from $11.65/lb to $18.97/lb), primarily driven by the restart of restocking.
• M&A activity was active: after Liontown Resources rejected Albemarle's $3.7 billion acquisition offer, its market capitalization rose from $2.2 billion to $3.8 billion, implying potential upside from further M&A.
• Direct equity investments by EV companies in lithium miners to secure supply served as an additional catalyst for the price rebound.

Copper:

• LME copper prices fell 5.91% in May to $3.66/lb, mainly due to disappointing Chinese data:
• April industrial output grew only 5.6% year-on-year, well below the expected 10.9%.
• April credit data showed new loans at a six-month low, with medium- to long-term household loans (a proxy for mortgages) recording the largest decline in 15 years.
• However, copper inventories across the three major exchanges are extremely low, with inventory coverage ratios continuing to decline; the global copper concentrate market is expected to face a deep shortage from 2025 to 2027, as new smelting capacity in Asia far exceeds mine supply growth.

Nickel:

• LME nickel prices plunged 15.60% in May to $9.27/lb, marking the fourth-largest monthly decline in a decade.
• Beyond Chinese macro data, news that Chinese nickel producers are seeking certification of nickel cathodes as "LME deliverable grades" exacerbated the decline. To boost liquidity, the LME has shortened the contract period for new brands (from one year to three months) and waived fees, raising market concerns that a large volume of non-deliverable grades could flood warehouses, suppressing prices in the short term.

Key Comparison Data:

Metal/Index	Price on May 31	Price on April 30	Monthly Change	Monthly % Change	YTD % Change
Lithium Carbonate Spot ($/lb)	18.97	11.65	+7.32	+62.88%	-44.45%
LME Copper Spot ($/lb)	3.66	3.89	-0.23	-5.91%	-3.52%
LME Nickel Spot ($/lb)	9.27	10.98	-1.71	-15.60%	-31.63%
Nasdaq Sprott Lithium Miners Index	1,002.23	965.59	+36.64	+3.79%	+8.66%
Solactive Global Copper Miners Index	126.64	144.81	-18.17	-12.54%	-2.80%
Nasdaq Sprott Nickel Miners Index	791.96	867.18	-75.22	-8.67%	-12.98%

Companies/Assets Involved

• Livent-Allkem: Merger creating a lithium miner with a market cap of $10 billion; no specific data provided.
• Liontown Resources: Market cap rose from $2.2 billion to $3.8 billion after rejecting Albemarle's $3.7 billion acquisition offer; bullish (M&A upside).
• Albemarle Corporation: Acquisition offer of $3.7 billion rejected; bullish (industry consolidation trend).
• Chinese nickel producers: Seeking LME certification for nickel cathodes; bearish (short-term supply shock).
• Sprott-related indices: Lithium miners index up 3.79% monthly, copper miners index down 12.54% monthly, nickel miners index down 8.67% monthly.

Investment Implications

• Lithium: Short-term restocking and M&A activity offer trading opportunities, with direct equity investments by EV companies further supporting prices. Focus on integration premiums for lithium miners (e.g., Livent-Allkem, Liontown).
• Copper: Short-term macro pressures (Chinese data, U.S. rate hikes) present buying windows; long-term supply gaps (deep shortage from 2025 to 2027) and low inventories provide a structural bullish logic. Accumulate copper miners on dips.
• Nickel: Short-term downside risk exists due to LME deliverable grade certification, but the report views the impact as temporary, with long-term fundamentals unchanged. Adopt a cautious wait-and-see approach or enter after prices stabilize.