by Jeff Reeves | October 11, 2011 2:34 pm
Rare earth stocks seem like a no-brainer. If you take the whole idea of supply and demand, the inherent scarcity in rare earths would imply that the companies in charge of these elements would be great investments right now.
Unfortunately, buying rare earth stocks isn’t that simple. Investors need to understand the risks of this highly lucrative industry before considering dipping into rare earths.
First, let’s look at the biggest players. Molycorp, Inc. (NYSE: MCP) is one of the most popular because its $3 billion market cap and 5 million shares traded daily make it relatively stable. Molycorp operates mines primarily in California.
Smaller rare earth investments include Avalon Rare Metals (AMEX:AVL), which mines Thor Lake in Canada, and Rare Element Resources (AMEX:REE), which operates in both Canada and the U.S. Both rare earth stocks are worth around $300 million each, and both do upward of 1 million shares per day in stock volume.
Another rare earth stock would be OTC-traded Lynas Corp. (PINK:LYSDY), but despite its $2 billion market cap, investors should be wary of the mere 250,000 shares traded daily, as well as the fees and risks associated with trading a pink sheet stock like this. Lynas is headquartered in Australia and has operations in Malaysia.
So which, if any, of these stocks is worth a look?
Rare earths are used in aerospace and technology applications, from semiconductors to nuclear batteries to lasers, so they are crucial to a high-tech economy.
There are serious supply concerns because rare earths are so … well, rare. As a result, Western companies are trying to lock up far-flung rare earth suppliers. Reports continue to indicate that China is consolidating its control over rare earths — not building bridges with companies — and that means Lynas could feel the pressure from China in the Asia/Pacific arena.
Tread lightly with Lynas as a result.
As for Avalon and Rare Element Resources, the performance in the past 10 months is enough to cause serious concern. AVL stock is off 50% since Jan. 1, 2001, and REE is down 66% year to date. Supplies might not be abundant, but consumer spending has seriously slowed down demand, and these companies have been suffering. Both rare earth stocks have lost about 50% in the past three months alone.
That leaves Molycorp. MCP stock has performed the best out of all of these investments that play rare earths. But it still is down 27% in 2011, compared with about a 2% loss for the broader stock market.
Perhaps the only glimmer of hope is that Molycorp stock was hanging tough until September, when an analyst slashed his price target from $105 to just $66. He cited the fact that rare earth prices have fallen substantially and demand outside China continues to decline.
MCP stock recently plunged 30% in about six weeks down to the middle $30 range — significantly below the lowered target of $66, so perhaps Molycorp could be oversold.
Of course, a seismic shift in the rare earths sector could significantly alter the outlook for these stocks. Western nations talk about reducing dependence on foreign oil from unfriendly countries, and could very well start feeling the same way about importing rare earths from China — the industry’s main supplier — in the years ahead. China produces nearly 95% of the world’s rare earth materials.
It’s also worth noting that extracting rare earths can sometimes be a very messy business with huge environmental impacts, and backlash or new regulations could grind production to a halt and crimp supply from U.S. and Canadian mines. Even China is focusing on improving pollution controls in its notoriously toxic mining and processing industry. China recently reported it largely shut down its rare earth industry for three months to address pollution problems, which resulted in the huge spike in rare earth element prices this summer.
Perhaps most disturbing is that China has been imposing tariffs and quotas on its rare earth exports for some time. The shock to global supplies has seen spikes in the 17 rare earth elements as much as 40 times above levels just a few years ago.
Demand is only part of the equation. If China continues to monkey with the supply chain, rare earth prices could soar, and all these stocks might firm up.
But investors should take a large dose of caution in the short term. Rare earth miners are risky plays, as the sector’s recent sharp selloff proves. Molycorp might have a price target almost 50% above current valuations, but the fact that MCP stock has languished at these “oversold” levels for more than a month proves investors aren’t as optimistic about the sector as they once were.
A rare earth stock could be the bargain buy of the century right now if the chips fall right. Then again, it could be a gamble that loses you a big chunk of change.
Jeff Reeves is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks named here. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.
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