Don't Buy Rare Earth Stocks Until You Read This

The investment thesis for rare earth elements has hinged on headlines of China cutting exports of the elements to the rest of the world. We were thrown for a loop not only because there aren't any major mines in operation outside of China but because demand for these products is inelastic, meaning the prices have gone through the roof.

In turn, shares of Molycorp (NYSE: MCP  ) , Rare Element Resources (AMEX: REE  ) , and Avalon Rare Metals (AMEX: AVL  ) have been soaring since mid-2010 in anticipation of cash flow from their mines. But it turns out these elements were more common than the market thought even as China cut its export quota.

China was supposed to cut exports by 40% in 2010 to 30,000 metric tons, except that never really happened. It turns out, China actually shipped 39,813 metric tons last year, according to the China Customs Statistics Information Center. That's only 9.3% lower than 2009, not nearly enough to justify the run we've seen rare earth stocks go on.

I've been punching holes in the rare earth thesis for some time now, but this is the icing on the cake. Sure, supply is short right now, but over the next few years there is a lot of supply coming on the market. Yes, demand is high now, but manufacturers are showing a willingness to modify their products to cut the use of rare earth elements. Now that we know China is shipping more rare earths than even it anticipated, the investment thesis for rare earths has taken another blow.

The wildcard going forward is word that China's Ministry of Land and Resources has taken control of 11 rare earth mining districts in China. The agency has taken over the mines because illegal mining is pushing more products into the market than China would like. Maybe this year we won't see China bust through its quota like it did in 2010?

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  • Report this Comment On January 24, 2011, at 1:58 PM, hudsondusters wrote:

    Travis, read up on MCP's new secondary offering today. Read pages 133-135 or thereabouts of the prospectus. Does that imply some if not all the lock up being pushed back 90 days? Delaying the inevitable i think, and of course a secondary is more dilution anyway (and convert holders tend to short since they are nedged on the upside). Looks like the current shorts got squeezed (the idea of "dump on lock-up expiry" was a crowded trade, and the market loves to undermine the common expection). After this run-up ends, my guess is slide begins again. Although they'll try any tricks they can to keep a good market as the insiders slowly sell-out at the high prices.

  • Report this Comment On January 24, 2011, at 3:11 PM, TMFFlushDraw wrote:

    @wobatus

    You may be right on the run up to lockup. Wednesday will be an interesting day. The date was also reported incorrectly in multiple places including Seeking Alpha, just to make the trade even more confusing.

    I have briefly looked at the announcement today so I will check out those pages closely when I read it. This article was written before the release came out so I wasn't able to include any information from it in this piece.

    Thanks for the comment,

    Travis Hoium

  • Report this Comment On January 24, 2011, at 3:51 PM, jimtsims wrote:

    Travis --

    A quick note regarding China's 2010 rare earth exports that may put this issue into some additional perspective.

    China supplies more than 97% of the world's rare earth needs. Thus, the world practically lives on what China exports. China's 2010 exports of 39,813 metric tons compare to a total annual rest-of-world (outside of China) demand of about 55,000 metric tons. This fairly large supply-demand imbalance is why rare earth prices have risen to strongly over the past year. It also is why 2010 saw outright shortages of some rare earths.

    China's recently announced 1H2011 quotas continue the downward trend of the past seven years. In the view of many rare earth market watchers, this portends further rare earth shortages in 2011, and perhaps into 2012.

    These trends, and other market fundamentals, is why Molycorp announced today our intent to increase our production capacity at our Mountain Pass Rare Earth Facility beyond our initial Phase 1 target of 19,050 tonnes/year by the end of 2012 to a Phase 2 production capacity of 40,000 tonnes/year by the end of 2013.

  • Report this Comment On January 24, 2011, at 5:55 PM, hongchang wrote:

    you are so naive to think that China will continue to export RE in the quantity of majority of the world supply. It did export 39k tons last year but majority was exported before they started tightening up the controls in later half of year. You will be lucky to see that number at 30k this year and 20k next. In about a couple of years down the road, China will stop exporting this material all together! That is what I know from reading all major Chinese news portals. All the Chinese support to stop exporting right now. But government can not do that because they need to abide WTO rules. But there is no rule to force them to export 90% of world supply on 30% of world storage. That's going to change very quickly!

  • Report this Comment On January 24, 2011, at 8:50 PM, WhoSays123 wrote:

    jimtsims, I assume you are with Molycorp (MCP), if so, congratulations on hoodwinking the market.

    MCP has already previously announced on 4 occasions the intention to bring capacity to 40,000 tons/year at some point. The most recent pump was done by announcing it through "TheFlyOnTheWall.com". I consider that shameful. Why pump it 4 times? In addition, another "secret" that was in the filing which isn't being publicized is MCP's statement that even though the capacity will be increased to 40,000 tons, MCP will only sell what the market needs. This indicates to me that MCP also understands there could be oversupply by the time the 40,000 comes to market.

    In addition... in the filing, it says the further dilutive event of $174M offering is to fund Phase 1 and Phase 2. WHy Phase 1?? Did MCP run out of $$ for Phase one? If so, why be secretive about this part?

    In addition, Lynas is coming online this quarter. Others around the world are stepping up (India for example). as you can see, Chinese quotas mean nothing as they shipped 15% over and above their year quota. Furthermore, MCP does not have many of the heavy REEs (1% of overall reserves, correct?).

    By the time MCP will be producing at 20,000 tons, there will be multiple players world wide and there will no longer be a shortage of supply. Even Toyota an others are moving away from REEs altogether. WHy is this not being publicized?

    Furthermore, there's one HUGE development at NO investment newswires are reporting on and that happens to be an issue the evironmentalists are pursuing regarding shutting down the natural gas pipeline to Molycorp due to an endagered turtle. This could theoretically disrupt many plans for you, no?

    Last but not least... your comment in regards to the Chinese lowering quotas even more... that's false. Round 1 quota 2011 is 80% higher than Round 2 quota 2010 sequentially. When supply rises from one day to the next, that means price should drop, no? The hype surrounding a maximum $2B market i find revolting. This is an attempt to swindle money from hard working folks that don't know any better. I find that sad. They don't understand that the quota is 80% HIGHER than it was the previous round! Instead you, and folks in the media keep comparing it to Round 1 Quota 2010 which is 1 year prior. That makes no sense. My house value changes based on demand from yesterday to today. So does Gold, and everything else. As does Rare Earths! I wouldn't be surprised to see round 2 REE quota from China go up another 80% from Round 1!

    I'm trying to be respectful as possible, but I just have issues when the full facts are not presented in order to paint a pretty picture to sustain a stock price which is 2-4x the entire world market for REEs (especially when MCP doesn't have the more expensive heavy REEs)).

  • Report this Comment On January 25, 2011, at 11:43 AM, prescient11 wrote:

    Does anyone commenting on this space know what the hell they are talking about. First, since we are talking about a relatively small amount of tonnage here, let's get the figures right, shall we.

    They did not EXPORT pure elements that was equal to 39,800k tonnes. You are confused.

    They actually exported around 34-35k tonnes of the pure elements.

    The remaining 5k (approximately) were exported via a part of an already put together product - there have never been export quotas on that type of rare earth usage. I.e., a magnet or some other product was already near its component or product end stage, with the REEs in them, and then shipped out.

    We will see what the final numbers are for 2H 2011, but I believe that they will, at most, be equivalent to 2H 2010 export quota figures, which means that 2011 will be yet another year of drastic quota reduction in the facing of ever increasing demand.

  • Report this Comment On January 25, 2011, at 11:44 AM, prescient11 wrote:

    Whosays:

    Lynas is coming online this quarter, eh. I will wait for that with baited breath.

    I imagine that Lynas, if it really has solved its metallurgical issues, will not come online until 2012, but we shall see.

  • Report this Comment On January 25, 2011, at 2:30 PM, WhoSays123 wrote:

    prescient11, it turns out, we DO know what we're talking about

    For the period of Jan to Nov 2010, shipments of rare earth exports was 35,000 tons vs 30,300 quota for the YEAR. This does *not* include December. So, add about 3K (3K/month avg) to that and you get 38,000 tons vs 30,300 quota. This is reported by CHINA. This is only on exports that relate to the quota. So nice try on the elements vs finished goods comment.

    Next...

    Where do you get the idea the 2nd half 2011 will be equivalent to 2nd half 2010? If you go back just 2 years, you'll find the 1st half 2010 was *higher* than 1st half 2009 (22283 in 2010 vs 21728 in 2009). Everyone freaked on the 2nd half quota in 2010 when it was 7976 vs 28417 in 2009. Yes, that sounds alarming, but turns out, demand was not extremely high, thus they didn't want to over supply. Did anyone hear of any shortages of finished goods during this drastic "cut" in production? No? didn't think so... BUT the cut sure was HYPED and thus prices skyrocketed.

    but then the 1H 2011 quota came out at over 14,000 which is 80%+ higher than 2H 2010.

    Basically what I'm saying is it is all over the map. There's no way to predict what 2nd half quota will be because there's nothing to base it on. It goes up and down every year. China even said to not derive any 2nd Half numbers based on 1st Half quota and to do so would be wrong. But you have not heeded their caution and instead just want to hype and pump.

    In addition to Lynas coming online this quarter...

    On this point, i do stand corrected. Upon further research, it shows they will be producing in Q3 2011 with full production in Q4 2011. A full year before MCP. http://www.lynascorp.com/page.asp?category_id=2&page_id=...

    For the record, i own zero shares or any interest whatsoever in Lynas.

  • Report this Comment On January 25, 2011, at 3:39 PM, prescient11 wrote:

    Who says:

    You are mistaken and I can prove it with cites rather than just saying it. See this Bloomberg article:

    http://www.bloomberg.com/news/2011-01-21/china-2010-rare-ear...

    More specifically, this quote:

    "China exported 39,813 metric tons of rare earths elements in 2010, according to customs data released today."

    And then this line, key to read here is CUSTOMS DATA - not export quotas:

    "The government set an export quota of 30,258 tons for 2010. This counts only oxide, while customs data include ore, oxides and compounds, so the reported figure is larger than the quota, Peng Bo, an analyst at Guosen Securities Co., said by phone today."

    Second, I would be wary of any Australian company's disclosures, as they do not have the same regulations as CA and US. While LYC may be in production then, they are trying never before used ore and the metallurgy is not proven. My guess is they will be ok, but let's just say I anticipate significant delays... What I'm saying here is that LYC Is a crapshoot, I prefer the canucks and yanks.

    Third, yes yes yes, I have heard morons continue to talk as if the 1H was a big increase from 2H '10. But you are correct in that no one knows what the 2H will be. But that's the whole point, companies are screaming about it now, it's on the PRESIDENT'S and Sec. Clinton's desk, you just can't run a company like this, waiting for the Chinese to figure out whether they are going to export x, y, and z crucial inputs into your products.

    I want to hype and pump eh? My position is that the quota will remain significantly below demand (which they currently are from annual 2010 figures) and this will continue to worsen. This is based on pure facts and information on the industry. You can call it hype and pump all you want, but let me just riddle you this. Never, and I mean never, have I seen so many people try to call this a "bubble" the whole way up.

    So many have so much wrong on this sector it gives me confidence that I'll be laughing at the naysayers all the way up. But who knows for sure, I definitely don't. But my position is based on logic and research and I would respectfully submit that 99% of the so called "authorities" have no frigging clue what they are talking about.

  • Report this Comment On January 26, 2011, at 11:05 AM, prescient11 wrote:

    I will await the mea culpa.

    I suggest further research be done before articles like this are written.

  • Report this Comment On January 26, 2011, at 3:30 PM, WhoSays123 wrote:

    There is no mea culpa because one isn't necessary. Thank you for posting the link and clarifying the numbers. I do appreciate that.

    HOWEVER, MCP's current valuation assumes that it's worth more than the *entire* Rare Earths market combined TIMES 2-3!

    You do realize MCP's operation is not scheduled to be at 20K tons until end of 2012, right? Now they have announced the 40K plans but won't be ready until end of 2013.

    The rest of your post is based on your "feeling" that Lynas will not be operational this year. This is not fact. This is feeling. Then you go on to say "it's on the president's desk" etc... there's NO evidence you have any idea what is on the president's desk. Once again, this is pumping. The US military uses 10-20 tons of rare earths yearly. 10-20 is *not* an issue. This isn't even 0.0005% of the rare earths.

    You also have not commented on the highly valuable rare earths which are the "heavies"... MCP doesn't have any. Well ok, they have 1% of their entire reserves as heavies. 1%! The heavies make up a huge bulk of the rare earths dollars in the marketplace. MCP will not be servicing that market very well.

    You have also not commented on Toyota and others going AWAY from rare earths altogether on their battery/engine technologies. This is a big deal.

    Furthermore, you assume further quotas will go down significantly based on your "feeling" that it will do so. There's no fact to back that up unless you use a 1 year change as a trend. You cannot do this.

    You are free to invest as you wish. However, I prefer to deal with facts and that's how i operate.

    If you want to look at fundamentals, check out TC vs MCP

    TC does over $500M in revenue right now at 30%+ margins and is valued at 2.2 billion dollars. MCP does 15M in revenue currently with a huge loss per share and that's projected to continue at least until end of 2012 if they're lucky. But, they're valued at about $4 billion! How does this make any sense?

    Furthermore, even if MCP does 20,000 tons, that would give an estimate of $300M (assuming many heavies in that figure, which we know is not right), at 20% margins that would equal about $1.00 per share in profits (less actually). The miners avg PE is about 12 (Check TC, FCX, etc...). This prices them at about $12 per share assuming future earnings go off spectacularly well. But since there will be big supply coming in by Lynas and MCP into the market, rare earths prices WILL fall. When that happens, profitability goes out the window.

    So, fundamentally speaking, MCP is extremely overvalued and it appears the insiders and/or the underwriters (Dahlman Rose anyone?) are extremely good at pumping the share price and keeping it there. Does anyone know what the secondary offering of $174M is priced at? no? Why not? That's somewhat important, no?

    You do realize MCP has 410M shares authorized and 82M shares issued. Theoretically, MCP can issue 300M+ more shares at any time.

    In addition, why is MCP not answering the question about Phase 1 not being fully funded? The prospectus on the secondary said the proceeds of the $174M will be used to fund Phase 1 and Phase 2. Phase 1 is for 20,000/year. What happened? Did they run out of money?

    Also, how come no one at MCP has mentioned anything about the potential environmental group suing to stop the natural gas pipeline from supporting MCP's project? This can potentially shut them down, no? At the very least, can delay operations for a significant period of time.

    I'm interested in hearing your feedback on that prescient11

  • Report this Comment On January 26, 2011, at 6:55 PM, zoodiverse wrote:

    Honestly does anyone believe what China says anyway, their whole plot consist around using REEs to build their little version of silicon valley, MCP still remains our only national blanket to bring manufacturing back to the US as we hear more about, independence,competition, and jobs ,blah blah,..besides ,where else am I going to get REEs for the flux capacitor of my Delorean?

  • Report this Comment On January 27, 2011, at 12:57 AM, prescient11 wrote:

    Whosays,

    The article was not a MCP specific piece nor do I have any interest in defending MCP's market cap.

    I do however take issue with your analysis and I think that MCP will eventually be in the triple digit price range. It is not the in situ value that this is based on, it is MCP's knowledge and downstream technology that will justify that.

    But I'm not invested in MCP, so that is that. What I am more concerned about is authors that seem not to understand that the shortage in the REE sector is very intense and will continue until at least 2015 and alternative supplies need to be developed now!

    As far as Toyota trying to move away from rare earths, I'm not sure what you're talking about, that story had its own Bloomberg article. Further, these potential design arounds will take a long time to implement. If Toyota had an endless, stable supply of REEs available, they would be selling a lot more Priuses. Maybe a new design will work, but that is many, many years down the road. So, the new applications for REEs are continuing to boom (see microrefrigeration) and yet the supply is dwindling.

    This needs to be addressed immediately or end user manufacturers will grind to a halt as they await the inputs. And we are talking BILLIONS of dollars. For example, WR Grace uses REEs (roughly $50MM worth) to achieve a $17B annual savings in its refining business. $17B annually! There will come a point in time when it makes sense for them to simply buy a deposit and lock up all supply needed to make sure they can continue to achieve this efficiency. And I think this is exactly what will happen.

  • Report this Comment On January 28, 2011, at 3:00 AM, renderus wrote:

    According to the USA Department of Energy in any case scenario there shall be critical Rare Earth shortages for the next 15 years. Particularly critical for Dy Tb Y Nd Eu.

    Page 72 identifies only 7 Non Chinese companies in Rare Earth Production by 2015: Alkane Lynas and Arafura in Australia, Great Western and Avalon in Canada, Molycorp in the USA and Dong Pao in Vietnam.

    See USA Department of Energy summary and full reports, and Center for Strategic and International Studies (CSIS) video presentation links:

    http://www.energy.gov/news/documents/Critical_Materials_Summ...

    http://www.energy.gov/news/documents/criticalmaterialsstrate...

    http://csis.org/multimedia/video-rare-earth-elements-keynote

    Zhang Anwen a leading Chinese government advisor and Deputy Secretary General of Inner Mongolia Rare Earth Guild who in Beijing conference Spring 2010 said:

    “Foreign countries should calmly and logically think about this and develop their own mines for their own needs. Our (China) resources are diminishing and we (China) need these minerals for our own use.”

    (Minutes 2:46 to 3:20 in the 6:19 minute video)

    http://www.youtube.com/watch?v=MHs2lGsqFKU&p=19D44B68A08...

  • Report this Comment On February 03, 2011, at 7:49 AM, renderus wrote:

    Stick with the hot Rare Earth Miners, especially the 6 in production by 2015: Alkane, Arafura, Avalon, Great Western, Molycorp and Lynas.

    Consider:

    American Security Project 1 February 2011 links:

    A prestigious U.S. defense think tank says the country’s current dependence on Chinese rare earth metals will harm future U.S. military and economic needs.

    http://americansecurityproject.org/news/2011/u-s-security-th...

    http://americansecurityproject.org/news/2011/new-report-high...

    http://americansecurityproject.org/wp-content/uploads/2011/0...

    http://americansecurityproject.org/wp-content/uploads/2011/0...

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