Will Chinese Rare Earths Bury Defense Industry?

In recent years, the attention of investors and the media has focused mainly on the spectacular rise of companies linked to digital technologies and artificial intelligence. Around "AI" and the broader tech sector, there has emerged an almost speculative bubble atmosphere, regardless of how real that threat actually is. Meanwhile, almost unnoticed and in the shadow of this euphoria, another industry has been marching forward at full speed: the defense industry, particularly in Europe.

The share price increases of defense companies in recent years have been equally impressive, and sometimes have even outpaced the valuations of major technology giants, yet they remain outside the mainstream attention of retail investors and the public.

Fortress Europe

The past year was a strong one for global stock markets, but the defense sector stood out in a remarkable way. According to data from Yahoo Finance, the aerospace and defense industry outperformed the S&P 500 by almost half in terms of returns. This trend is even more evident in Europe, which has become the main beneficiary of massive rearmament programs. The Stoxx Europe Targeted Defence index rose by more than 160 percent over the year, and the largest companies, especially German ones, have posted truly spectacular results. Rheinmetall and Hensoldt both recorded gains exceeding 300 percent, and their valuation multiples are now often comparable to those of technology firms, sometimes even surpassing them.

It seems that Europe has ended its pacifist episode and is methodically shifting its vast industrial base toward military production.

A cynic might say that while China and the United States are investing hundreds of billions in algorithms that generate unemployment and steal copyrights, European factories are churning out trainloads of ammunition and tanks.

The source of such dynamic valuation growth is, of course, the steadily rising defense spending across Europe. Importantly, rearmament here is not viewed merely as a short-term economic stimulus but as part of a long-term strategy for security, modernization of the armed forces, and building industrial self-reliance.

Faced with the increasingly aggressive behavior of Russia, the EU member states have adopted a deterrence strategy based on overwhelming military strength. One of the most telling indicators of this shift is the surge in defense expenditures among the European members of NATO, which are rising at a pace unseen in decades and are increasingly defining the continent’s security priorities.

For many years, the bloc struggled even to reach the 2 percent of GDP defense spending target. Recently, however, European NATO members have not only met that benchmark but have also announced a new and ambitious goal, 5 percent of GDP devoted to defense. That effectively means more than doubling military budgets.

Equally important, if not more so, is the fact that the European part of the alliance has also increased the share of funds allocated to new equipment and capabilities, from roughly one-quarter to about one-third of total defense outlays. In practice, this means that the real increase in weapons procurement is even greater than the headline growth in total defense spending suggests.

A question arises: is there anything that could stop, or at least slow down, the awakening of the giant that is the European defense industry? Market valuations suggest not, yet a closer look reveals several important risk factors.

These include, above all, concerns about public finances, demographic trends, and environmental policy, all of which significantly hinder industrial expansion. But beyond these obvious threats, there is one more, far greater risk. That risk is China.

Far East, Close Problems

The design philosophy of the European and Western defense industries has long been characterized by what is known as the "gold-plated solutions" approach.

This term refers to the fact that the armed forces of the collective West have always paid a high price for technological superiority over their adversaries from the global East and South. The West has long been accustomed to the idea that this advantage requires significant financial investment. The defense industry, much like the high-tech sector, functions on the principle of a continuous innovation race, where high spending is the price of maintaining superiority and saving soldiers’ lives.

However, in order to maintain technological dominance, rising defense budgets and access to skilled personnel are no longer enough. The foundation of modern weapons systems lies in rare earth metals, whose unique properties make it possible to build advanced sensors, electronics, engines, and guidance systems. Without them, European defense designs would not only lose their competitiveness but would, in practice, regress by decades. Tanks, aircraft, and missile systems deprived of these key components would resemble equipment from the Cold War era rather than weapons suited to the realities of the twenty-first century.

China has begun deliberately restricting access to rare earth elements. Export limitations and increasingly complex administrative procedures mean that Western countries are facing not only higher costs but also the real risk of supply chain disruption. This is a clear signal that Beijing is consciously using its dominant position in this sector as a tool of political and economic pressure.

The key question that arises is how serious Europe’s dependence on imports from China really is.

As shown in available data, the situation appears quite serious. Most of the key European countries involved in arms production obtain more than half of their rare earth supplies from China. The situation is particularly critical in Italy and Germany.

The European Union is attempting to reduce its dependency on China and on imports of rare earth metals from third countries. However, the effectiveness of these efforts remains limited. What makes the problem even more complex is that the EU still obtains around 28 percent of its rare earth metals from Russia, a country directly responsible for the current arms race.

• Given such critical dependencies and the very high market valuations in the sector, a number of important questions arise.
• Who is most exposed to potential disruptions in supply chains?
• Who could emerge from a potential crisis relatively unscathed?
• What alternatives to China and Russia does Europe really have?
• And who stands to benefit if the continent becomes self-sufficient in sourcing rare earth elements?

The Glow of Metals, the Shadow of Dependence

Every modern engine, radar, guided missile, or communication system contains traces of rare earth elements. This means that their shortage would hit the most advanced defense projects the hardest. However, different companies have varying levels of exposure to these materials. For some, supply disruptions would cause only delays and reduced competitiveness, while for others they could result in a near-total loss of production capacity. So which of Europe’s defense giants have the most to lose?

Rheinmetall (RHM.DE) - Rheinmetall is the undisputed heavyweight of the European defense industry. The company is significantly dependent on rare earth elements. Its annual report explicitly states that trade restrictions with China would force a reorganization of supply chains and result in higher costs, confirming its systemic vulnerability. The most at-risk segments are those responsible for radar and sensor systems, which use elements such as dysprosium, terbium, and yttrium.

The company’s pride, however, could also become its burden in case of shortages: its land systems division. The production of turrets, drives, and servomechanisms relies heavily on neodymium and samarium-cobalt magnets. The ammunition segment, on the other hand, which has gained significant importance since 2022, shows relatively low dependence on rare earths. 

Possible consequences of shortages include:

• Delays in fulfilling its record order backlog
• Revenue shifts between quarters, reducing transparency in reporting
• Margin pressure due to increased costs
• Additional expenses related to redesigning and qualifying substitute materials
• Growing capital expenditures and working capital needs due to stockpiling

Under a base-case scenario with moderate supply tensions, the impact on valuation is limited. However, if disruptions persist for 12 to 24 months or longer, the company’s valuation could fall by 6 to 12 percent as a result of margin erosion. In a severe restriction scenario, market capitalization could drop by 12 to 20 percent, driven by declining profitability, delivery delays, and higher capital requirements. 

Because of its size and market role, any significant downturn in Rheinmetall’s stock could trigger negative sentiment across the entire European defense sector.

On the positive side, Rheinmetall’s operations are diversified. The company states that it actively seeks to diversify suppliers and has contingency plans in case of market disruptions. Given its strategic importance, Rheinmetall would likely receive both formal and informal support from the German government in case of serious difficulties.

HENSOLDT (HAG.DE) - Hensoldt, a manufacturer of advanced optoelectronic systems for the German defense industry, is one of the best examples of a company heavily dependent on rare earth materials. While its official communications emphasize the importance of supply diversification, import data tell a different story.

The company requires not only neodymium and samarium-cobalt magnets for drives, but also consistent supplies of lanthanum and yttrium for optical and laser production. This makes Hensoldt highly vulnerable to any disruption in supply chains. To make matters worse, there are few realistic technological alternatives or material substitutes available.

Like Rheinmetall, Hensoldt’s share price has surged dramatically, and its current P/E ratio hovers around 150, a very high level even by growth-stock standards. As a result, any serious supply chain crisis in rare earth elements could lead to a 15 to 25 percent drop in valuation, posing a significant risk for investors.

LEONARDO (LDO.IT) - The Italian company Leonardo is one of the cornerstones of the European aerospace and defense sector, and it too remains significantly dependent on rare earth imports. Magnets play a crucial role in the company’s propulsion and control systems, but Leonardo also uses heavier rare earth elements essential for its in-house production of optoelectronics, infrared emitters, lasers, and high-temperature-resistant structural components.

Compared to its German counterparts, however, Leonardo has taken a more consistent approach to supply chain diversification, which substantially mitigates its risk exposure. While shortages could still impact its valuation, projected declines are estimated at 5 to 10 percent, far less severe than those facing German peers.

ROLLS-ROYCE (RR.UK) - The British company’s presence in the defense sector is primarily tied to the production of ultra-modern jet engines, which serve as the backbone of many European and allied aerospace programs. This makes Rolls-Royce particularly sensitive to rare earth shortages.

A key component in its engines is yttric-stabilized zirconia, used in thermal coatings that protect engines under extreme operating conditions. In the event of significant shortages, Rolls-Royce would lose not only its production capability, but also the ability to service existing engines.

For investors, this represents considerable downside risk. In a severe scenario, the company could lose 20 to 30 percent of its market value.

BAE SYSTEMS (BA.UK) - One of the largest defense contractors in the world, BAE Systems operates across nearly every segment of the defense market, with particular strengths in naval and aerospace domains. The company’s scale means it consumes large volumes of virtually all categories of rare earth materials—from lighter elements used in optical systems and actuators to heavier ones required in advanced sensors and guidance systems.

However, thanks to its broad portfolio, global diversification, and robust supply planning procedures, BAE Systems is among the more resilient players in the sector. In the event of supply disruptions, the potential decline in its share price would likely be limited to 5 to 10 percent, significantly less than that of most competitors.

Power Without Minerals

Not all defense companies are under pressure from limited access to rare earth metals. Some operate in segments that require far fewer critical elements, and their valuations remain more reasonable than those of high-tech defense giants. Moreover, geopolitical tensions and rising defense budgets continue to open up new opportunities for them.

The war in Ukraine has painfully exposed how the West has long neglected the development of personal protection systems for soldiers. Modernization in this area has become a necessity if European armies are to meet the realities of future conflicts. This, in turn, means rising demand for high-quality protective equipment. Companies operating in this niche are now benefiting, offering technologies that directly improve survivability on the battlefield.

Avon Protection – a British manufacturer of gas masks and personal protection systems. The company is benefiting from rising military orders linked to chemical and biological threats, and its business model is largely immune to commodity price fluctuations.

Lubawa – a Polish producer of protective gear, bulletproof vests, tents, and uniform components, recently expanding into anti-drone systems. Its products do not require rare earth metals, and growing defense budgets in Central and Eastern Europe make it one of the regional beneficiaries of the current military boom.

Chemring Group – specializes in the production of ammunition, countermeasure systems, and missile defense technologies. Although it uses modern components, its exposure to rare earth metals is limited. Stable long-term contracts with governments make Chemring a relatively safe player in volatile times.

Colt-CZ Group – a Czech-American firearms manufacturer known for its small arms production. The segment it operates in requires virtually no rare earth elements, while demand for handguns in Europe and beyond remains strong. The company benefits from the defense buildup without additional raw-material risks.

QinetiQ – a British technology firm providing testing, simulation, and unmanned systems solutions. While some of its projects may involve rare earth elements, its overall exposure is relatively small. Its business model relies primarily on know-how and service contracts rather than raw material inputs.

The Old Continent, New Solutions

Why doesn’t Europe simply switch its rare earth supplies to other sources? On paper, this might sound simple and logical, but market reality quickly proves otherwise. China controls the majority of global rare earth production and processing, dominating every stage from extraction to refining.

China built this dominance by leveraging a unique advantage: control over almost half of the world’s known reserves. Beijing looked ahead, took risks, and pursued a consistent long-term strategy that free-market economies simply could not match. Systemic planning, backed by political decisions, gave China a decisive edge over a few decades. Another critical factor has been the absence of strict environmental regulations and minimal regard for public opinion. While in Europe or the United States similar investments would trigger waves of protest, in China entire regions have been devastated by toxic mining without significant political consequences.

As a non-democratic state, China is not among the most transparent market players. Much data never reaches the public, and even those that do are often viewed with skepticism. Still, analysts have been able to estimate the country’s industrial capacity and compare it with global demand. The results leave little room for doubt: the world remains heavily dependent on Chinese supplies, and this structural asymmetry underpins Beijing’s current leverage.

Yet all is not lost. There are still alternatives that can gradually reduce China’s dominance. Although Beijing controls most of the global value chain, significant deposits also exist in Australia, the United States, and parts of Africa. These regions, supported by political initiatives and private investment, are stepping up efforts to expand their own mining and refining capabilities. The process is costly and time-consuming, but it shows that the world is not entirely at China’s mercy.

The problem, however, is that many of these potential alternative suppliers are politically unstable regions in the Global South. Many show open sympathy toward authoritarian regimes in Russia and China, raising doubts about their reliability as strategic partners. The United States, meanwhile, has demonstrated in recent years that it is not always a trustworthy ally when it comes to long-term trade commitments.

Adding to the challenge are rising geopolitical tensions and state-sponsored terrorism, which increasingly threaten global shipping routes. Faced with these realities, Europe has little choice but to focus on one strategy: maximizing independence.

It took the COVID-19 pandemic for the West to realize that free trade and open borders are not guaranteed forever. It took Donald Trump to demonstrate that alliances can be far less stable than they appear. And it took Russia to remind Europe that peace on the continent is neither natural nor permanent.

Now, returning to the drawing board, Europe can try to redesign some systems to use simpler and more accessible alternatives to rare earth materials. The magnet segment offers the greatest flexibility, as partial substitution is sometimes possible without major performance loss. Unfortunately, when it comes to emitters, radars, sensors, or optical systems, the quality trade-offs are usually unacceptable or outright impossible.

Another hope lies in the growing understanding of production processes, which allows for significant optimization of material usage. Yet no degree of optimization can solve the fundamental challenge: the lack of raw materials.

The Critical Raw Materials Act (CRMA) is a pan-European initiative designed to address this structural vulnerability. The act sets out that the European Union must not only diversify its sources of supply but also invest in developing its own capabilities in mining, refining, and recycling.

The CRMA establishes ambitious targets for 2030:

• At least 10 percent of strategic raw materials should come from extraction within the EU.
• More than 40 percent should be processed domestically.
• A minimum of 15 percent should return to circulation through recycling.
• At the same time, the act limits dependence on any single external partner to no more than 65 percent of imports in any given category.

This is not only a technical roadmap but also an economic and political declaration that Europe intends to reduce its vulnerability to resource blackmail, even if that means higher costs and confronting its own environmental standards.

A number of European companies are emerging as potential direct beneficiaries of the CRMA. The initiative is driving the development of local supply chains, opening opportunities for both mining and processing firms and recycling specialists. In practice, this could result in a severalfold increase in the value of assets that until now have remained on the margins of the market.

Solvay – The Belgian-French chemical group with a long history in materials and energy industries. In April 2025, Solvay launched a line for processing Nd/Pr materials used in magnet production. The company aims to cover 20–30 percent of Europe’s processed REE demand within a few years, becoming a cornerstone of EU self-sufficiency.

REEtec — A Norwegian startup specializing in rare earth separation. Commercial operations begin in 2025 at its Herøya plant, with an initial capacity of 720 tons of NdPr per year. Long-term offtake agreements provide stability and a solid foundation for growth.

Grupa Azoty — Poland’s largest chemical company and one of Europe’s biggest in its field. In partnership with Canada’s Mkango, it is developing a rare earth separation project in Puławy, aiming for 2,000 tons of NdPr and 50 tons of Dy/Tb annually by 2030. The project is classified as “strategic” under CRMA.

Carester — A French firm focused on recycling and reusing rare earth elements. Its Lacq hub, supported by a €216 million public-private partnership, will handle separation, oxidation, and metallization, with operations set to start in 2027.

Neo Performance Materials - A Canadian-Estonian group with decades of experience in REE production and processing. It owns the Silmet plant and will open a sintered magnet factory in Narva in 2025, initially producing 2,000 tons annually, expandable to 5,000.

HyProMag - A subsidiary of Mkango, originating from research at the University of Birmingham. It is developing HPMS technology for magnet recovery from electronic waste, targeting 500 tons per year of recycled magnets in the EU by 2030.

LKAB - The Swedish mining giant and iron ore supplier, long a pillar of its national economy. In Luleå, it is building an experimental platform for recovering phosphorus and REE from iron ore processing, with full operations expected by 2029–2030.

Rare Earths Norway - A Norwegian exploration firm developing REE deposits in the Fen region, aiming to produce 2,000 tons of Nd/Pr annually by 2031, following permit approvals and infrastructure construction.

The biggest threat to these European initiatives remains the high cost of electricity. Separation and refining processes are extremely energy-intensive, and Europe’s energy prices are among the highest in the world, making these operations less profitable from the start.

A second major obstacle lies in regulatory procedures and strict environmental rules. Many potential deposits are located within Natura 2000 protected areas, particularly in Scandinavia, where the largest reserves are found. Emission and environmental restrictions make many extraction methods impossible, and the ones that are allowed tend to be unprofitable. Bureaucratic delays in permitting can easily stall or block key projects. 

One cannot ignore the inevitable protests and sabotage by environmental groups, some of which act as proxies for Russian and Chinese interests in Europe.

Recycling of rare earth metals presents its own enormous challenges. It is technologically complex and expensive, though European researchers are making progress in scaling up these processes.

Transportation and storage also remain difficult due to the toxic, flammable, or even radioactive nature of some materials and ores. The silver lining is that refined rare earth products have a very high value density: a single kilogram can cost anywhere from tens to several thousand euros, making logistics viable despite the difficulties.

Even in the most pessimistic scenarios, a total collapse of European defense production is highly unlikely. The risks are concentrated more around financial indicators of listed companies than around the continent’s actual ability to maintain weapons output.

Still, it would be naïve to believe that even the best implementation of the CRMA, or similar initiatives, could fully resolve the issue. Europe faces structural constraints: high energy costs, regulatory delays, environmental limitations, and a simple geological reality — the continent lacks sufficient reserves to achieve full self-sufficiency.

Most importantly, it should be understood that the future performance of the companies discussed will be shaped by a wide range of factors: from complex technical issues, through political decisions and geopolitical tensions, to detailed legal and regulatory frameworks.

This means that the analysis presented here represents only one of many possible scenarios for how the situation may develop and does not constitute investment advice.

Investing Beyond the Stocks?

Importantly, investors are not limited to picking individual defense stocks. It is also possible to gain exposure through ETFs and ETCs, which offer a broader and safer way to invest in the defense and resources sectors, where volatility and regulatory risks can be significant.

At the base of this investment chain are mining ETFs, which include companies involved in the extraction, processing, and trading of industrial metals. These firms form the foundation of modern industry, both civilian and military. Mining companies are often the first to benefit from higher commodity prices and geopolitical tensions that boost demand for strategic materials. One example is WMIN.DE, which includes global mining leaders producing both traditional metals and critical elements used in advanced technologies. Such ETFs still have significant growth potential, particularly given Europe’s underinvestment in mining and its plans for reindustrialization.

A second category consists of rare earth ETFs, such as REMX.US, which track companies engaged in mining, separating, and refining elements like neodymium, praseodymium, dysprosium, and terbium. These materials are essential for magnets, lasers, sensors, and guidance systems — the core of modern military technology. ETFs in this segment allow investors to participate indirectly in one of the world’s most strategic industries, characterized by both enormous potential and high political sensitivity.

The third pillar of exposure comes from defense ETFs, such as FTGA.DE, IVDF.DE, or DFEN.DE, which focus on global defense and aerospace manufacturers. Their portfolios are dominated by US giants that have historically led the sector but are now being challenged by faster-growing European peers. While instruments offering exposure solely to European defense firms are still rare, global diversification helps reduce risk. Such ETFs give investors access to both Pentagon-funded US contractors and European firms benefiting from large modernization programs.

For those seeking even broader diversification, ETCs (Exchange-Traded Commodities) provide a way to invest directly in commodity prices rather than in the companies that produce them. Unlike ETFs, which follow equity indices, ETCs are linked directly to the spot prices of raw materials. This provides investors with pure exposure to commodities, independent of corporate performance.

In practice, ETCs are mostly available for mainstream commodities like copper, crude oil, and gold, all of which also play important roles in the defense and mining industries. Copper is essential for electrical systems, oil powers military logistics, and gold serves both as an industrial material and a store of value. Although ETCs do not yet offer direct access to rare earth metals, they remain an important part of a well-balanced commodities portfolio.

All these instruments are interconnected, representing different stages of the same value chain — from raw material extraction to processing and final weapons systems. However, their correlation is not perfect, allowing for portfolio diversification and risk reduction. Mining ETFs in particular still hold strong upside potential, given the growing global demand for strategic resources.

Kamil Szczepański

XTB Junior Financial Market Analyst