Mining Sector Ideas

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Molycorp -- >>> Molycorp and the Return of Rare Earth



By Douglas Ehrman
MF

August 28, 2012



http://beta.fool.com/dsewrites/2012/08/28/molycorp-and-return-rare-earth/10696/?ticker=MCP&source=eogyholnk0000001



While most companies in the rare earth space have tumbled over the last several months, two significant catalysts were recently announced that have the potential to reverse this trend. First, Molycorp Inc. (NYSE: MCP) announced that its Phoenix Project in Mountain Pass, California began operations on schedule and is expected to reach full Phase 1 production during the fourth quarter. The after-hours announcement drove the stock higher in extended trading, but the full impact may not be known for many days. Molycorp is largely considered the top contender and standard-bearer for the rare earth industry. The second potentially catalytic event was the announcement by China that it was raising the export quotas for rare earth materials for the first time in seven years. China, which is disproportionately the largest producer of these materials in the world, has kept a stranglehold on exports in order the meet internal demand.

The Mixed View of Molycorp

It is difficult to soften the strength of the diametrically opposed opinions of Molycorp and the whole rare earth sector. One group believes that despite the cataclysmic fall from grace that the company has experienced, it remains significantly overvalued. Those in this group liken the rise in rare earths to a bad fashion fad that has run its course for the foreseeable future. On the other side of the proverbial aisle are those who believe that at the currently depressed levels, the company and its peers represent deeply discounted values. The above catalysts are likely to initiate a power struggle in the near-term, but understanding the position of each side can help one form an informed, and less reactionary, opinion.

On the side of the detractors is the fact that the best rare earth companies – Molycorp and Rare Element Resources (NYSEMKT: REE) – have barely remained in the black for investors who have owned them since the beginning, while the rest have experienced significant losses, including Avalon Rare Metals Inc. (NYSEMKT: AVL) and Lynas Corporation Ltd. (LYSCF). They believe that the bubble has burst and that, as global macroeconomic conditions remain unfavorable, the price of these commodities will continue to decline, taking the stocks’ prices with them.

On the pro side of the argument is the demand profile of the materials themselves. These substances are critical components of such passing fancies as cell phones and hybrid cars. Despite the fact that China has experienced its own economic slowdown, demand growth is dramatically outpacing changes in supply. To put this in context, Chinese demand is now in the realm of 64% of all global production, up from 25% in recent years. The demand from China alone is eclipsing the uptick in supply to the extent that it is nearly impossible to imagine that prices will not climb over the long-term. Lastly, the Australian Mount Weld project controlled by Lynas is expected to contain the richest concentration of rare earth materials in the world. The poor performance of the stock aside, this mine reaching full production may loosen the Chinese grip on the market.

Placing the Catalysts in Context

As commodity prices have strengthened, largely in anticipation of the Federal Reserve’s latest round of quantitative easing, focus may have returned to rare earths. The announcement made by Molycorp concerning its progress in California is bullish for the stock and the market. As the “spotlight” name of the group, increased attention on the prospects for rare earths should be a net positive for these names.

While on its face, an increase in supply from China might be seen as a negative for suppliers, as was discussed above, demand so far outpaces supply that an easing of the Chinese chokehold is also positive. The move comes after both the U.S. and Europe lodged fair trade complaints about the Chinese policy with the World Trade Organization (WTO). It should be noted that despite the announcement of the policy shift, exports of rare earths have actually decreased by nearly 37% in the first part of the year. It is the move in policy that should be the takeaway from this news, as a more open market should benefit all participants.

Trading Molycorp

Prior to the most recent price bump, the company had hit successive 52-week lows. At these levels, the company is a good play in the speculative part of one’s portfolio. While it is difficult to say when the move will come, there is a high probability that rare earth stocks will recover significantly at some point. Given that the stock traded near $60 within the last year, the risk-reward profile is very favorable. If the company reversed its fall by even 50%, that would spell a three-bagger for investors (200% return). While not appropriate as a core holding, there is a solid case for maintaining an allocation to Molycorp.

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