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Why China wants North Korea's rare earth minerals

A front loader shifts soil containing rare earth minerals to be loaded in Lianyungang, China, which accounts for about 90 percent of the world's rare earth production.
STR | AFP | Getty Images
A front loader shifts soil containing rare earth minerals to be loaded in Lianyungang, China, which accounts for about 90 percent of the world's rare earth production.

As investors and economists worry about global spillover effects on commodities by a slowing Chinese economy, one key resource is bubbling under the radar—stockpiles of rare earth metals in neighboring North Korea.

The category of minerals called rare earth is a misnomer. The chemical elements are available throughout the world, and have tongue-twisting names such as cerium and lanthanum. But rare earth minerals are key to everyday tech gadgets and growing innovations, such as smartphones, high definition TVs, hybrid cars, missiles—even the extraction of natural gas known as fracking.

Rare earth metals have had a low profile compared to other metals and commodities like crude oil. But more recently, demand for mobile technology, smartphones—and minerals needed to manufacture those goods—has been rising. China, meanwhile, is a leading producer and consumer of electronic goods. And Chinese leaders want to secure a steady supply of rare earth elements—including stockpiles in North Korea, which largely has been isolated for 60 years, and is being used in addition to its own vast supplies.

That North Korea even houses any strategic resource may be surprising. But underneath the barren landscape lies metric tons of valuable elements, desired by China and other tech-consuming nations.

Amid strong global demand, North Korea's mining sector is a cash generator with plenty of supply. And the young North Korean leader Kim Jong Un is grappling with how to best manage that industry, which is integral to the regime's future. With North Korean property rights not clearly defined, "political factions" compete for assets and rents derived from the mines, said Marcus Noland, a leading researcher on the North Korean economy.

"One of the things they've been really trying to do is centralize and control this process," Noland said in an interview with CNBC.com last week.

(Read more: How rare earth elements are used)

Better than plain dirt

Some Asia watchers have characterized Kim's recent purge of senior leaders as unsettling to reforms. Jang Song Thaek, an uncle of the North Korean ruler, had accumulated an unusual level of business influence before he was executed in December.

(Read more: Being a North Korea 1 percenter just got dangerous)

Jang "had good contacts in China, no doubt about that," said Noland, executive vice president and director of studies at the Peterson Institute for International Economics in Washington. "But fundamentally, this relationship is being driven by the fact there are valuable minerals under the ground in North Korea, the North Koreans don't really know how to mine and process them, the Chinese have a great demand for those minerals.

Marcus Noland
Heesun Wee | CNBC
Marcus Noland

"And because of North Korea's diplomatic isolation, Chinese are effectively monopsonistic purchasers of those minerals, which is to say they get those on good terms," Noland said.

The new critical resource: Minerals

Roughly 10 to 15 years ago, there were few incentives to pin down future rare earth reserves. Now nations are jockeying for the resource. Select minerals, for example, have allowed for ever-smaller smartphones with more powerful processing power. World leaders have entered the rare earth fray through trade disputes.

Amid high demand, it's hard to pin down North Korea's reserves and production. China accounts for just over 90 percent of the world's rare earth production, but new regions are coming on board, including in the U.S., Canada, Kazakhstan, Malaysia, Australia and Greenland. And Chinese production could be closer to 40 to 50 percent during the next 20 years as new players come on board, said Kristopher Rawls, senior economist at IHS Pricing and Purchasing, a global economy forecaster.

The largest rare earth mine outside of China is owned by Molycorp and located in Mountain Pass, Calif., east of Los Angeles. Annual capacity is about 19,000 metric tons, or about 14 percent of global capacity.

But while market diversification may be welcome, China has a firm eye on its future that includes a populous nation, hungry for consumer electronics that require rare earth metals. Take your smartphone, for example. China envisions extracting raw materials and then managing production to the final end product. "They want that entire supply chain," Rawls said.

Was your smartphone made with North Korean minerals?

North Korean rare earth elements raise questions about whether your smartphone was manufactured with minerals from a totalitarian regime. Reports of human rights violations have been in the public domain for years. Now, a United Nations report released this week offers the highest-profile, international attempt to investigate those claims.

Requirements to track so-called conflict minerals—similar to identifying diamonds from conflict zones—do exist. But Rawls said rare earth from North Korea likely is undergoing multiple layers of processing, so any trace amounts in end products probably are minimal. "It's certainly possible," Rawls said.

Ironically, the exchange of rare earth minerals and other free-enterprise ventures are opening the regime to perhaps the most precious commodity of all—unfiltered, outside information.

(Read more: North Korea's most coveted snack)

"This is a slight exaggeration of caricature but basically what happens is the North Koreans go to China with suitcases of cash and a wish list, and they collect the consumer goods," said Noland, who has traveled to North Korea several times. "The Chinese drive them up to the border. They offload these things off the Chinese trucks, and it's up to the North Koreans to go off and peddle." Everything from pirated DVDs of South Korean soap operas to cognac are sold inside the North Korean capital's tolerated markets.

The net effect? The western side of North Korea bordering China has become a supply chain for goods and outside information. Imported items in the markets suggest many North Koreans have either been to China or know someone who has, said Noland, co-author of the book "Witness to Transformation: Refugee Insights into North Korea."

On a trip to North Korea a few years ago, Noland asked locals what they discussed in the markets. He got a surprisingly international response: "The Middle East." As Noland explains, "The market literally becomes a conduit for information because of the way it's organized, requiring people to leave the country."

By CNBC's Heesun Wee. Follow her on Twitter @heesunwee, Google or send her an email.

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