Rare Earth Portfolio Construction: Strategic Allocation and Risk Management

Building a high-conviction rare earth portfolio requires disciplined position sizing, correlation awareness, and multi-scenario planning. Rare earths are highly volatile; positions should be sized relative to portfolio risk tolerance and time horizon. Strategic diversification spans element exposure, company types (miners, processors, magnet manufacturers), and geographic concentration risks.

Position Sizing Framework

Asset Allocation by Portfolio Risk Profile

• Conservative (low volatility tolerance): 1-3% of portfolio in rare earths (ETFs only; no single stocks)
• Moderate (balanced): 3-8% of portfolio; mix of ETFs (50%) and individual stocks (50%)
• Aggressive (high conviction): 8-15% of portfolio; mix of stocks (60%), ETFs (20%), direct commodity (20%)
• Speculative (high volatility tolerance): 15-30% of portfolio; concentrated in highest-scarcity plays (Dy, Tb producers)

Position Size Guidance

• Single stock position: Max 2-5% of portfolio per company (except established integrated producers)
• Sector concentration: Max 10-15% of portfolio in total rare earth sector
• Geographic concentration: No single country >40% of REE allocation (China, USA, Australia concentration limits)
• Element concentration: Magnet REE plays (Nd, Dy, Tb) should dominate allocation (70%+); LREE tactical only

Diversification Strategy Across Element Exposure

Magnet REE Tier (Highest Priority)

• Allocation: 60-70% of rare earth portfolio
• Focus elements: Nd (50%), Pr (20%), Dy (20%), Tb (10% - highest scarcity)
• Rationale: Magnet REEs are supply bottleneck; EV/wind demand drives 90%+ of growth
• Companies to target: Integrated producers (mining + separation); alloy producers; magnet manufacturers

Heavy REE (HREE) Specialty Tier

• Allocation: 15-25% of rare earth portfolio
• Focus elements: Dy (dominant), Tb (ultra-scarcity play), Gd (secondary)
• Rationale: Dy/Tb face most severe supply constraints; extreme pricing premiums
• Risk: Smaller market; fewer investment vehicles; higher company-specific risk

Light REE (LREE) Tactical Tier

• Allocation: 5-15% of rare earth portfolio (opportunistic)
• Focus elements: La, Ce (industrial catalysts); Y (phosphors)
• Rationale: Less supply scarcity; lower growth; use as portfolio stabilizer when prices peak
• Timing: Overweight LREE when magnet REE prices spike >80th percentile (rebalance hedge)

Diversification Across Company Types

Integrated Producers (Mining + Separation)

• Allocation: 40-50% of rare earth stock picks
• Companies: Rare Element Resources (Nd/Pr), MP Materials (Nd dominant)
• Upside: Full value chain capture; highest margin potential
• Risk: Highest capex requirements; longest permitting timelines; binary execution risk

Separation-Only Specialists

• Allocation: 20-30% of rare earth stock picks
• Focus: Companies with magnet REE (HREE) specialization
• Upside: Leverage to supply bottleneck without mining capex risk
• Risk: Input cost pass-through risk; China competition

Magnet Manufacturers and Downstream

• Allocation: 20-30% of rare earth stock picks
• Companies: Companies with NdFeB magnet production capacity
• Upside: Benefit from magnet demand growth; some input cost insulation via contracts
• Risk: Compressed margins if REE input costs spike faster than output contracts adjust

REE-Exposed Equity Funds and ETFs

• Allocation: 10-20% of rare earth portfolio (broad diversification)
• Benefit: Lower single-company risk; automatic rebalancing
• Trade-off: Wider exposure includes non-core REE names; diluted pure-play scarcity exposure

Geographic Diversification

Production Concentration Risks

• China: 60%+ of global supply; geopolitical risk (export controls, policy changes)
• USA: Mountain Pass only major producer; permitting delays; strategic national security focus
• Australia: Lynas increasing capacity; high-quality HREE; Malaysia political risk exposure
• Myanmar: 9% monazite supply; geopolitical instability; supply shock risk

Portfolio Allocation by Geography

• China-exposed: Max 35% of rare earth portfolio (country concentration limit)
• USA-exposed: 20-30% (strategic/policy stability)
• Australia-exposed: 15-25% (growing capacity; geographically diversified)
• Rest of world: 10-20% (Myanmar, Malaysia, Africa opportunities)

Scenario Planning and Stress Testing

Bull Case Scenario (2024-2028)

• Assumptions: EV production +20% CAGR; no major new supply; geopolitical scarcity premium persists
• Price outcome: Nd $110-150/kg; Dy $350-450/kg; Tb $2,500-4,000/kg
• Portfolio impact: Integrated producers +150-250%; magnet REE stocks +100-200%
• Position sizing: Can tolerate larger allocation (8-15% of portfolio)

Base Case Scenario (2024-2028)

• Assumptions: EV production +12-15% CAGR; moderate new separation capacity; policy stability
• Price outcome: Nd $65-85/kg; Dy $200-280/kg; Tb $1,500-2,200/kg
• Portfolio impact: Integrated producers +50-100%; magnet REE stocks +30-80%
• Position sizing: Standard allocation (5-10% of portfolio)

Bear Case Scenario (Supply Relief)

• Assumptions: New separation capacity exceeds demand growth; EV production slows
• Price outcome: Nd $40-55/kg; Dy $120-160/kg; Tb $800-1,200/kg
• Portfolio impact: Integrated producers -30-50%; magnet REE stocks -20-40%
• Position sizing: Reduced allocation (2-5% of portfolio); focus on ETFs/diversification

Crisis Case Scenario (Geopolitical Shock)

• Assumptions: Chinese export controls; supply disruption; war risk
• Price outcome: Nd $150-250/kg; Dy $400-600/kg; Tb $3,000-5,000/kg (similar to 2011)
• Portfolio impact: Integrated producers +250-500%; magnet REE stocks +200-400%
• Risk: Market dislocations; liquidity challenges; government price controls possible

Rebalancing Strategy

Tactical Rebalancing Triggers

• Price extremes: If Nd >$100/kg, trim 25% of position; if <$50/kg, add 25% to position
• Company-specific catalysts: Major capex announcements, production guidance changes trigger evaluation
• Supply announcements: New separation capacity exceeding forecast triggers rebalancing down
• Policy changes: Export control news triggers 5-10% portfolio-level adjustments

Annual Rebalancing

• Quarterly review: Check allocation vs targets; don't trade on minor deviations (<5%)
• Annual rebalancing: Trim outperformers; add to underperformers
• Tax-loss harvesting: Identify underperforming positions; harvest losses to offset gains

Key Portfolio Metrics to Track

• Portfolio beta: Rare earth portfolio likely 2-4x market beta (high sensitivity)
• Correlation: Rare earth stocks typically 0.5-0.8 correlated with each other; low correlation with broad market
• Maximum drawdown: Expect 30-50% drawdowns in bear markets; position size accordingly
• Sharpe ratio: Rare earth portfolio typically 1.5-2.5 on long-term basis (high risk-adjusted returns)

Key Takeaways

• Position sizing: 3-10% of portfolio standard for most investors (higher for high conviction)
• Diversify across magnet REEs (60-70%), HREEs (15-25%), and LREEs (5-15%)
• Mix company types: integrated producers (40-50%), separators (20-30%), manufacturers (20-30%)
• Geographic diversification: No single country >40% allocation
• Rebalance on price extremes and major announcements; don't over-trade