Despite being described as “rare,” rare earth elements (REE) are found in products you use every day, from laptops to iPods to flat screen televisions and hybrid cars (which use more than 20 pounds of REEs per car). They’re critical in green energy applications such as solar panels and windmills. Catalytic converters wouldn’t function without REEs. They’re everywhere you turn.

Beijing slashed its annual export quota for REEs by 40 percent in July, a troubling development because China accounts for 95 percent of global supply. In 2007 China produced more then 120,000 tons of REEs; India was the second-largest producer of REEs with a mere 2,700 tons. Consequently, Beijing’s export controls sent REE-related stocks soaring. Shares of Molycorp (NYSE: MCP) and Lynas (ASX: LYC) have more than doubled in recent months and Avalon Rare Earth Metals (TSX: AVL) and Dacha Capital (TSX: DAC) have seen their stock prices rise by more than 50 percent.

The reduced export quota, and reports that Beijing would halt shipments of some REE products to Japan amid a political tussle between the two countries, has been manna to conspiracy theorists. But the facts are simple. There’s a limited supply of a critical resource that the Chinese need to fuel their own economic growth; some estimate that China might not meet its own domestic demand for REEs in as little as two to five years.

China’s REE industry is also highly fragmented, with a multitude of small and large players as well as numerous illegal miners in operation. While constricting supply will certainly boost China’s pricing power and build a stockpile of REEs, it will also help consolidate the industry.

Despite all the fuss, rare earth elements aren’t all that rare. Some are more commonly found in the Earth’s crust than nitrogen. But mining and refining REEs is costly and toxic. Mitigating the environmental impact of poisonous and radioactive byproducts is an expensive regulatory nightmare, so the prices of REEs have to be extremely rich to motivate new production. That’s why the production of REEs was essentially ceded to China in the 1980s, when environmental considerations were hardly on Beijing’s radar.

But after nearly 30 years out of the game, it will now take anywhere from seven to 15 years for the US build up its own domestic industry, though bills have been introduced to Congress that would provide incentives and loan guarantees to encourage speedier development. In fact, Molycorp owns a property in Mountain Pass, Calif. that was once a prolific producer of REEs until environmental costs made the mine uneconomical. Avalon Rare Earth Metals also owns a significant REE deposit in Canada’s Northwest Territories.

Investors can purchase a number of individual stocks to take advantage of the REE run. But there aren’t any exchange-traded funds (ETF) that play on the theme here in the US, except through some form of derivative exposure. For example, holding iShares S&P Global Materials (NYSE: MXI) provides some exposure to REEs because several of those elements are produced in other mining activities.

A purer play may soon be available though. Van Eck Global filed a preliminary prospectus with the Securities and Exchange Commission in June, notifying the agency of Van Eck’s intent to form a new Market Vectors Minor Metals ETF. While it wouldn’t be a pure play on REEs–the fund would invest in mining operations engaged in the production of about 30 lesser-known metals–it would be the best option for US investors.

We don’t know when the fund will launch, what expenses will be charged or even a proposed ticker symbol. But I expect it to come to market sometime in the first quarter of 2011. Until then, ETF investors seeking exposure to REEs will have to content themselves with other options.

What’s New

September was a busy month for ETFs with 27 new funds launched and $27.9 billion in net asset inflows. Much of that asset growth came at the expense of traditional actively managed open-end mutual funds, which continued to experience significant asset outflows as investors opted for cheaper index ETFs.

With more then $412 billion in assets under management in its iShares lineup, BlackRock, Inc added three new emerging market ETFs to its stable last Wednesday:

• iShares MSCI China Small Cap Index (NYSE: ECNS)
• iShares MSCI Philippines Investable Market Index (NYSE: EPHE)
• iShares MSCI Brazil Small Cap Index (NYSE: EWZS)

iShares MSCI Brazil Small Cap Index will face stiff competition from Market Vectors Brazil Small-Cap ETF (NYSE: BRF), which beat the new iShares fund to market by more than a year. Over that time Market Vectors Brazil Small-Cap ETF has accumulated about $1 billion in total assets and generates an average daily trading volume of almost 350,000 shares.

iShares will likely face difficulty accumulating assets. Both Brazil funds employ passive indexing strategies and hold the same basic names. There’s also little price difference between the two funds–iShares charges an annual 0.65 percent expense ratio compared to 0.71 percent for the Market Vectors fund.

If you already own Market Vectors Brazil Small-Cap I don’t see much reason to make the switch given the lack of liquidity in iShares MSCI Brazil Small Cap Index. But a change might make sense in the future.

iShares MSCI China Small Cap Index is also facing off against an established competitor. Guggenheim China Small Cap ETF (NYSE: HAO) has been trading for more than two years and has accumulated assets of almost $425 million.

In addition to a small price gap–Guggenheim charges 0.70 percent while the iShares fund charges 0.65 percent–there are some significant differences between the two funds. The Guggenheim portfolio holds 155 components while iShares tracks a deeper bench of about 350 companies. Guggenheim is also slow to respond to capitalization drift and has a tendency to select companies too large to be accurately labeled as small-caps; just 6 percent of Guggenheim’s holdings are classified as small-cap or micro-cap.

iShares has a solid track record of running its funds according to their mandates, and iShares MSCI China Small Cap Index should be a good fit for investors looking for exposure to Chinese small-caps. But you should hold off until the fund builds its daily volume.

The first ETF to focus exclusively on the Philippines, the new iShares MSCI Philippines Investable Market Index fills a significant gap in the industry’s single-country coverage. With an abundance of natural resources and a thriving electronics industry, the island-nation’s economy has posted strong growth since the fall of dictator Ferdinand Marcos in 1986. The nation has also benefited from deepening trade relations with the rest of Asia.

The real drawback to investing in the Philippines is its extreme concentration. As of 2009 there were just 248 listings on the Philippine Stock Exchange and the fund will run a portfolio of about 27 holdings with a heavy concentration in financials. Unfortunately, there’s no way around that if you want to invest in the country.

Finally, UBS E-TRACS 1x Monthly Short Alerian MLP Infrastructure ETN (NYSE: MLPS) also launched on September 29.

I take a longer-term view of the markets and generally don’t recommend inverse (or short) exchange-traded products. Inverse products periodically reset for tracking purposes sometimes even on a daily basis; in this case, the ETN will reset on the first trading day of each month. These periodic resets skew investment results and make inverse ETFs and ETNs inappropriate for long-term holding.

Given the explosion of MLP-related products coming to market–there are currently seven–it was only a matter of time before an inverse fund hit. This is one I would definitely leave for the traders.