This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

Injury's bad; insults are worse
Strange as it sounds to say it, I feel sorry for Goldman Sachs (NYSE: GS  ) today. In a high-profile story in the Wall Street Journal this morning, Wall Street's "paper of record" relates how Goldman got in early on the rare-earths boom, joining other private equity players to buy Molycorp (NYSE: MCP  ) from Chevron (NYSE: CVX  ) for a mere $80 million. Just two years later, Goldman ditched its shares -- just before the company IPOed, beginning its run to $4 billion in value.

Now we learn that the real profits at Molycorp may only just be beginning. Yesterday, two of Wall Street's best and brightest issued "buy" recommendations on Molycorp. In twin "buy recs," Morgan Stanley reinstated its coverage of Molycorp with an "overweight" rating, and JPMorgan upped its own recommendation for the shares to "buy."

According to Morgan Stanley, Chinese export quotas on rare-earth oxides, combined with heightened enforcement against illegal exports of the metals, "could cause supply outside of China to fall by as much as 40%." Meanwhile, Molycorp is making progress toward capitalizing on any resulting shortages, obtaining "mining permits, financing, and commercial agreements." Plus, the company is partnering with other businesses to begin production of value-added alloys and magnets, creating the potential for Molycorp to become much more than just a miner of raw materials. It all adds up, in Morgan Stanley's thinking, to a stock worth $63 a share minimum -- and perhaps as much as $140 a share.

Echoing its near-namesake's view, JPMorgan agrees that the rare-earth materials market is "undersupplied" and that prices on the metals will "move higher" -- high enough to approximate Morgan Stanley's $63 price target. Key to JP's thesis are Molycorp's plans to first reach 20,000 tons of rare-earth mineral production in 2013, then "double its production rate to 40k tones starting in 2014." While both targets remain a ways off, JP tells us it expects prices to "remain elevated over the next several years as supply remains constrained."

Both analysts may be right -- except for three things.

WTO vs. JPM
According to the Journal, rare earths prices are spiking across the globe. The market price for a ton of lathanium oxide is up 769% over the past seven months. Cerium oxide has jumped 990%. Broadly defined, the "rare earths run-up" has caused the stocks of miners from Molycorp to Rare Element Resources (NYSE: REE  ) to General Moly (NYSE: GMO  ) to spike sharply -- but it's also piqued the interest of international regulators.

Last week, the World Trade Organization issued a preliminary finding that declared China's export restrictions illegal, and it seems to me the WTO has a strong case. China's moves to restrict exports of the metals are clearly distorting pricing, and this is just as clearly contrary to China's obligations under free trade agreements. If and when China is required to roll back its export quotas, the sudden influx of supply on the market could crater the same stocks that have benefitted from this run-up.

Molycorp vs. the clock
How long until this happens? Hard to say, but if we're talking months instead of years, or even a single year instead of several, then Molycorp may not even make it to the point of producing JP's projected 20,000 tons per annum before the bottom falls out. As I pointed out back in December, while larger, better-capitalized companies like Thompson Creek (NYSE: TC  ) and Freeport-McMoRan (NYSE: FCX  ) are currently producing -- and profiting from -- rare earth mining outside of China, Molycorp really isn't yet. Right now, the company's producing just a fraction of JP's targeted production rate, and incapable of capitalizing fully on the rise in prices.

Wall Street versus Main Street
The third and final reason: JPMorgan and Morgan Stanley don't spend a lot of time worrying about the above two concerns. As StreetInsider pointed out yesterday, "both Morgan Stanley and JPMorgan were lead underwriters in the recent mandatory convertible preferred and secondary common stock offering and the company's July 2010 IPO." The analysts upgrading the shares today, after their 50-fold run-up, might be just a wee bit conflicted about the value of the Molycorp shares they now own.

I'm not saying they are -- just that they might be. Tell us what you think about Molycorp, and the analysts' opinions of it, below.

Chevron is a Motley Fool Income Investor recommendation, but Fool contributor Rich Smith does not own (nor is he short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 718 out of more than 170,000 members. The Motley Fool has a disclosure policy.

Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (5) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 23, 2011, at 12:50 PM, GEEMAN84 wrote:

    This is my first time here at The Motley Fool. This may have been mentioned before but I will comment anyway. If you define Rare Earths as "Rare Earth Elements" which are the elements that China controls and is squeezing exports then I believe you may have your facts wrong. Molycorp (MCP) will produce REE's ( they are currently producing from old ore) but Thompson Creek, Freeport and GenMoly do NOT produce any Rare Earth Elements.

  • Report this Comment On February 23, 2011, at 1:26 PM, cattywampus wrote:

    Like walking a tightwire over a mining pit while spinning plates on your nose. Unless your Bird Millman (Ringling Brothers) or Con Colleano, the Austrailian (Wizard of the Wire) you might want to venture out on this temperamental wire cautiously. It is an interesting stock and the global market is exciting to watch and that is all I've been doing as of late. I'll continue to enjoy the show from the nosebleed seats. If China becomes defiant of the WTO I would reconsider investing in heavy REE's.

  • Report this Comment On February 23, 2011, at 4:08 PM, kkconway wrote:

    Rich, I have never been to Las Vegas, and have no desire to go, but I do have a "Riverboat Sam" side to my personality when it comes to the market. Rather than look for the 10-bagger in MCP by going long, I have in real life, sold calls and bought puts in MCP and REE. So far, so good, since both are down a fair bit from when I made the trades in January.

  • Report this Comment On February 23, 2011, at 7:45 PM, MACV73 wrote:

    Wow--Not to be picky, but the rare-earths that the chins are playing kibuki games with are called the Lanthanides and are a group of elments not produced by either Freeport or Thompson Creek. Now Molycorp does produce these elements and will be back online in a couple of years. So, please don't let the facts get in the way!

  • Report this Comment On February 23, 2011, at 9:23 PM, smallcapbigyield wrote:

    My understanding is that the WTO's preliminary ruling was actually against a group of raw materials (that do not include rare earths)... Rare earths may become a target for complaints to the WTO, but they're not currently.

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