Buy, Sell, or Hold: Rare Element Resources

When considering any stock for your portfolio, don't be swayed just by the positives. Examine its pros and cons, and decide whether it's possible upside outweighs its risks. Let's take a look at Rare Element Resources (NYSE: REE  ) today, and see why you might want to buy, sell, or hold it.

Based in Colorado, the company has a market capitalization of about $160 million, meaning that it's relatively small. It's in the business of exploring for gold and rare-earth elements (hence, REE), with much of this being done in Wyoming.

The stock, which was trading in the teens in early 2011, was recently priced below $4 per share. That has some wondering whether it's now a bargain, or if it should best be avoided.

Buy
Two reasons to consider buying the stock are: It has fallen sharply, and over the long run there will be ongoing demand for rare-earth minerals. Those may not be the best reasons, though, as the stock may still be overvalued, prices may keep falling, or the company may just not perform well in the future. Still, it's good to understand what these minerals are, and how they're used – in electric-vehicle batteries, fiber optics, smartphones, flat-screen displays, oil refining, and more.

On the plus side when we look at its financial statements, there's no debt, and enough cash to keep the company in business for a while, judging from its cash flow patterns. (There are more red flags than green ones, though, in these reports. I'll get to those soon.)

A glance at a recent company presentation offers more pluses (as, of course, we'd expect), such as: Its Wyoming operations represent the "second-highest-grade rare-earth deposit in North America." It even thinks that China might be importing rare-earth minerals within a decade.

Sell
One reason to consider selling REE is the main reason that its stock has fallen so hard: The prices of rare earth minerals, which were rather high not so long ago, plunged, taking REE and peers such as Molycorp (NYSE: MCP  ) and Avalon Rare Metals (NYSEMKT: AVL  ) with them. While it's true that demand for rare-earth minerals isn't likely to disappear, it's also true that some of the manufacturers that use them are finding alternatives, and that their supply may not be as limited as once thought, either. Toyota, for example, is aiming to build its hybrids and electric cars without these minerals, which might save it some money.

China can cause headaches for U.S.-based rare-earth companies, too, as it's a major producer. When it restricts its production, the supply shrinks and prices rise. Meanwhile, remember that Rare Element has competition, and all of the industry together might produce more volume than is needed, sending prices down.

The stock's price is another concern, sitting firmly in penny-stock territory, which is below $5 per share. Penny stocks are generally more easily manipulated than their bigger counterparts, and have caused many people to lose a lot of money.

Consider its short interest, too, reflecting those investors who have bet against it. Recently, about 6%, or more than one in 20, of its shares outstanding were shorted. That may not seem like much when compared to, say, Molycorp, which had 24% of its shares shorted. But REE is a smaller company, and its trading volume is lower, meaning that its "days to cover" its short position, at 9.1 days, is more than twice as high as that of Molycorp. Thus, if the stock starts rising significantly and shorters want to cover themselves, there may be a sustained period of buying as they do so, propping up the stock price somewhat.

A glance at REE's financial statements isn't encouraging, either. Revenue is negligible, and net earnings are net losses, and growing losses, at that. The company's share count has risen considerably, too, from around 23 million in 2008 to 44 million recently. That can shrink the value of existing shares and it's worth keeping an eye on.

In case you haven't already figured it out, the stock is also very volatile, moving much more sharply than the overall market. That isn't necessarily a bad thing, but if you don't have a strong risk tolerance, it is a bad thing.

Hold (off)
Given the reasons to buy or sell Rare Element Resources, it's not unreasonable to decide to just hold off on it. You might want to wait for it to start posting successive quarters of positive and growing earnings. You might want prices for rare-earth minerals to rise. You might want a clearer picture of the company's future to emerge.

Alternatively, you might check out some other interesting mining-related companies, to see if they inspire more confidence or offer more promise. REE's competitor Molycorp is one possibility, though it has considerable debt and some strong detractors. Silver Wheaton (NYSE: SLW  ) is another. It has been growing its revenue and earnings by more than 50% annually over the past three years, for example, while employing a lower-risk business model than most mining companies.

Another possibility is the Market Vectors Rare Earth/Strategic Metals ETF (NYSEMKT: REMX  ) , which gives you exposure to a bunch of rare-earth companies without your having to bet your farm on any one or a few. It also offers additional diversification, including some companies specializing in non-rare-earth metals that are nevertheless vital to industry – such as Thompson Creek Metals (NYSE: TC  ) , focused on molybdenum and aiming to expand into gold and copper.

The verdict
I'm holding off on Rare Element Resources for now, as its future seems too uncertain for my tastes. Everyone's investment calculations are different, though. Do your own digging and see what you think. The company may perform spectacularly in the coming years, but remember that there are plenty of compelling stocks out there.

If you're looking for a company whose success is determined by the metals market, but without having to involve itself in the risks of physically mining the metals, then Silver Wheaton provides a unique play on the future of silver. SLW chooses to finance the mining of silver; it has grown sales and net income every year since 2008, and also has increased competitive advantages over its limited peer group. More details about our outlook for Silver Wheaton can be found here in our Motley Fool analyst report.



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