For any who thought the rare earth bull was dead, last week’s earnings report by Molycorp (MCP) was a wake-up call. In fact, it might be the "All Aboard!" call from the conductor as this rare earth bullet train takes off to once again reward investors. The industry has been unfairly beat down, with investors repricing the shares at levels not seen in many months.
The general market conditions have changed, with the U.S. losing its AAA credit rating and Europe once again in the headlines. Rare earths on the other hand have been taken out to the woodshed for reasons we cannot comprehend, at least when the talking heads express their opinion. Rare earths have not been knocked down due to a huge find off of the coast of Japan, or spot prices falling for the first time in what seems forever. If anything with China still slowing exports and trying to keep rare earths within their borders, it seems these hard to mine elements have only become rarer! Yet the market participants have left the sector due to a flight of capital resulting from the risk trade once again being turned off.
What should be apparent to the market now is how profitable this sector can be, even on a small scale. This was on display in Molycorp’s ability to actually earn money while still ramping up production and not being anywhere near their desired scale. For those companies that have the ability to actually get these exotic elements out of the ore that they reside in, this will be a viable business. When MCP reaches full scale production, their shares could very well become super charged as analysts finally realize the revenue potential of their mined ore, and then make their own assumptions regarding the manufactured upstream products.
Lynas, an Australian miner that should be up and running by year-end, is another rare earth element play to watch. Lynas will be the first player to full production so long as the Malaysians do not cause them any further issues. We suspect both stocks, Lynas and Molycorp, should perform well, both in good times and bad, as the two companies are first movers and locking in contracts as we speak. MCP will be the more diversified of the two, in regards to product offering as it is vertically integrating, and Lynas plans to have a diversified production base as it horizontally integrates.
The real sleeper throughout all of this market turmoil has to be Rare Element Resources (NYSEMKT:REE). With MCP quickly proving American REE companies can be competitive, and quite profitable, this company’s prospects have only grown brighter. The Bear Lodge Project also holds more of the valuable HREEs than previously thought. See the company’s press release here. If REE can crack the metallurgy and get a separation process established, this project has the potential to be wildly successful in economic terms.
Taking a look at the Heavy Rare Earth Element (HREE) players, we see tremendous opportunity for those looking to establish positions at this level. This might have been the last leg down, the shake down of weak holders if you will, before the next powerful move up. That being said, our favorite HREE play thus far has been Quest Rare Minerals (NYSEMKT:QRM) based on the size of their deposit, the company’s ability to increase the tonnage and grade of that deposit, the mineralization being close to surface and the project being located in Quebec which is very miner friendly.
Also in the HREE sector, at these prices we would feel comfortable speculating in Avalon Rare Metals (NYSEMKT:AVL), which has always been a distant second to Quest in our book. Although we still think Quest is being valued at half of its real worth when compared to Avalon, we think both stocks should do very well as investors move back into the sector, with Avalon posting strong gains, just not as strong as Quest’s. Simply put, we think Quest has the ability to quickly double from these levels with Avalon seeing somewhere between 35-55% upside.
Nothing changed in the rare earth space over the past month or two except the general market movement and investors’ lack of risk appetite. The rare earth sector should bounce back strongly as the risk-on trade resumes and investors worry less about the return of their money and focus instead upon the return on their money. The rare earths are one of the few resource plays we see as offering tremendous rewards for investors through increased production and higher prices of the REEs once Japan’s manufacturing base cranks back up.
Disclosure: I am long QRM.