Molycorp: Don't Let 52-Week Lows Scare You Away

| About: Molycorp, Inc. (MCPIQ)

Despite recently hitting a 52-week low, and then hitting successive new ones since, Molycorp (MCP) has engendered some extreme feelings from investors and analysts alike. Once the darling of the market as commodity prices soared, carrying basic material companies to new highs, many of these stocks have been trounced. There are now two very distinct schools of thought on Molycorp and the entire rare earth space in general. One group claims that despite the decline, the stocks are still over-valued and a dangerous investment; this group believes that prices will continue to go much lower. On the other side of this argument is the group that points out the long-term prospects of the company and the short-term technical indicators that are pointing to higher prices. While both groups have some valid points that should be considered, it is only when these views are combined that a clear picture of the company emerges.

The Pro-Molycorp Case

Those who argue in favor of Molycorp, and the rare earth industry in general, begin by acknowledging that one must first overlook the carnage that has taken place in the price of these stocks over the recent period. Instead, advocates argue, one should focus on the underlying demand for these materials. A recent report by Resource Investor considers the supply and demand situation. China is the most significant player in these materials, accounting for the bulk of both supply and demand. As China has hit a few skids with its own economy, the prices of rare earth commodities have fallen from the highs they had reached during the parabolic climb of the last few years.

The two important factors to take away from the observable supply and demand trends are that demand is expected to continue to grow rapidly and the supply of non-Chinese options is expected to increase moving forward. To put this in perspective, Chinese demand has soared from 25% of global production to 64% of global production, all while there are steady supply increases apparent; Chinese demand alone is outpacing supply, meaning that it may soon become a net importer of these materials so that it can maintain its dominance in the production of high-tech products that require these elements. These products include cell phones and hybrid cars, neither of which is likely to fade away in the near-term.

Within the above context, Molycorp is well positioned having done a complete overhaul of its California mine and completed the acquisition of Neo Material Technologies. The combination of these two events is expected to bring the company's total production capacity to nearly 40,000 tonnes by the end of 2013. At a time when there is not likely to be a slowdown in demand, this is a great place to be for the company.

The Anti-Molycorp Case

Those who do not believe in the space point out that while Molycorp and Rare Element Resources (REE) have just managed to hold onto profits for those investors who have ridden out the storm, Avalon Rare Metals (AVL) is down about 50% since the stock went public. Australian competitor Lynas (OTCPK:LYSCF) has also maintained a strong position amongst its peers, but not as an investment. The global slowdown on a macroeconomic basis, and some shifts in China's otherwise arbitrary policies, have caused the bubble in rare earth materials to collapse. The price of these materials has the potential to go much lower, returning to levels not seen since 2009 and 2010. If this happens, these analysts argue, the price of each of these stocks has the potential to continue falling.

Adding to the general malaise caused by the global macroeconomic outlook is the fact that supply of these materials is increasing. This detail which was considered a laudable argument for the stock above is cited as a reason for concern by those who think these stocks are no longer attractive. These arguments fail, however, to place their supply concerns in the context of demand - if demand grows faster than supply, greater supply is not the negative that it is being held out to be.

Deciphering the Arguments

As is the case with most arguments, reality is likely located somewhere between the bulls and the bears. The explosive growth seen in this sector certainly had bubble-like characteristics and may have taken these stocks higher than was appropriate. On the other hand, the demand for these materials seems to be in a segment of the market that is not likely to decrease in the foreseeable future. While the global economy is nowhere near correcting many of its most deep seated problems, consumerism is not in any real jeopardy. Cell phones sales and demand for hybrid cars continues to increase consistently. As long as these products are of interest, the long-term future of the rare earth companies is not in any lasting peril.

The conservative investor is clearly better off putting his or her money into a diversified play like Freeport-McMoRan (FCX), particularly if dramatic swings are not within one's risk tolerance. With this in mind, a small allocation to the rare earth companies, and specifically to Molycorp, will likely be handsomely rewarded over the long-term. Making a small allocation at current levels, and buying additional positions at progressively lower levels, should they be achieved, will maximize the potential return will managing risk. Within the space, Molycorp is an acknowledged leader and is the right play for investors wanting such an allocation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.