China is limiting the supply of essential minerals to Western defense manufacturers, which is causing production delays and higher costs for U.S. defense companies. These minerals are vital for products ranging from ammunition to advanced weaponry, and finding non-Chinese suppliers is becoming increasingly difficult. Earlier this year, Beijing tightened export controls on rare earth elements due to escalating trade tensions with the U.S. Although some shipments resumed after U.S. concessions in June, China still restricts minerals needed for defense. Currently, China supplies around 90% of the world’s rare earths and dominates the production of many strategic materials.

Impact on the U.S. Defense Sector

A U.S. drone parts manufacturer reported delays of up to two months while searching for non-Chinese magnets. Industry analysts mention that prices for some minerals have skyrocketed. For example, one company was offered samarium, necessary for jet fighter engine magnets, at 60 times the usual price. This situation highlights the U.S. military’s reliance on Chinese supply chains. Many advanced defense technologies, such as drone motors, missile guidance systems, night-vision goggles, and satellite components, depend on rare earths mainly sourced from China. These supply restrictions give China an advantage during the ongoing geopolitical and trade conflicts. With China’s growing control over vital minerals needed for defense manufacturing, major defense contractor stocks are under pressure. In the last quarter, defense sector stocks have lagged behind the S&P 500 by nearly 8% as investors anticipate production delays and increased costs. This trend provides an opportunity for bearish investment positions in the coming weeks.

Investment Strategies and Market Opportunities

Traders should think about buying put options on major defense companies like RTX and Northrop Grumman (NOC) with expiry dates in late October. We expect these firms to provide weaker forward guidance during their next earnings calls due to ongoing supply issues. This strategy could allow us to profit from expected drops in their share prices after these announcements. On the other hand, non-Chinese mining companies are poised to gain significantly from this supply crunch. The VanEck Rare Earth/Strategic Metals ETF (REMX), which tracks global producers, has already risen over 15% since June due to the tightened restrictions. We see more potential for growth here and suggest purchasing call options on REMX or individual miners like MP Materials (MP) as a successful counter-strategy. The geopolitical landscape brings considerable uncertainty, likely leading to increased volatility. Implied volatility on options for the iShares U.S. Aerospace & Defense ETF (ITA) has surged to a 52-week high, indicating that the market is preparing for a major price shift. A long straddle on ITA could be an effective way to benefit from significant moves in either direction without predicting the outcome. We also recommend exploring opportunities in the underlying commodity markets. Just as cobalt prices soared during supply disruptions in the Democratic Republic of Congo in 2018, prices for certain rare earths like samarium and neodymium could experience sharp increases. Taking long positions in futures or stocks of producers focused on these elements offers a direct method to capitalize on the supply shortage. Create your live VT Markets account and start trading now.

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