Good And Bad News For Molycorp

| About: Molycorp, Inc. (MCPIQ)

A Malaysian court has set production back in a project by Molycorp's biggest non-Chinese competitor -- the Australian mining firm Lynas (OTCPK:LYSDY) -- by a month. Lynas, which went public in 1985, has been focused on rare earths since 2001. Lynas operates the Mount Weld mine in Australia, which has been in operation for one year now.

Lynas's Malaysian plant is the largest one outside China, and while it could have started production as early as May of this year, safety concerns by local activist groups have set the launch back a number of times. For Molycorp (MCP) and other rare earth producers, any delay of additional supply is good news.

The bad news is that the rare earth area is getting more and more crowded. It would take a separate article to get into detail about all of Molycorp's competitors. But to give you an idea of some of the other players, here are a few:

You can also look at the bottom of this page to see more competitors.

Molycorp and its competitors are commodity companies. More importantly, they specialize in commodities that are not easily tradable (like hogs or copper), and therefore their share prices tend to match rare earth prices very closely because investors use them as a tool. This is a point Molycorp CEO Mark Smith made at the annual shareholder meeting (see this video). Obviously, Molycorp's management is aware of the strong correlation between its stock price and rare earth prices, and it tries to combat that by marketing a proprietary chemical called SorbX and a range of similar products for water treatment. Another way Molycorp tries to stay afloat while rare earths prices are falling is by being a vertically integrated neodymium (used for magnets) supplier.

What is important to know about rare earths is that there are basically two kinds: the light ones and the heavy ones. The heavy ones are much more valuable and to get them you have to dig up a lot of the light ones. The most common light one is Cerium, which is used in SorbX products. Why should you care? Because there will be a huge overproduction of Cerium, and Molycorp needs some way to sell that at a premium to all the other Cerium suppliers -- that's what SorbX is for. That is why I will watch SorbX sales closely (they are not yet posted in the company's earnings report as an item, but are included in the Cerium line); perhaps Molycorp will let investors know how its SorbX products are selling on Nov. 5 when it reports earnings. To give you a rough idea of rare earth supply, global demand is in the area of 120,000-125,000 metric tones for this year. China's internal production quota is somewhere around 95,000 metric tones. That leaves a gap of about 30,000 metric tones. Molycorp's Mountain Pass alone could put out 40,000 metric tones in phase two production (by mid-2013). So unless demand goes up significantly, there will be plenty of overproduction flooding the markets and sending prices lower.

Molycorp is better positioned than its competitors because it is aiming at selling higher margin products and are the largest non-Chinese player as of now. In order to get bullish, I would like to see more management stock purchases like Ross Bhappu's, who bought 2.5 million shares in August at $10 a share. Mark Smith only invested $0.5 million on that day. Some insiders like Bhappu and Dolan last year sold shares for $293 million on exactly the same day (just like the rest of the insiders) at $51 a share. That's a price level the stock will never reach again if you ask me.

I didn't dare touch Molycorp during its wild rise in 2011, but now I trade the stock because of it's "mood swings." Right now I own Molycorp stock, but that can change very soon. When buying commodity stocks, it is all about the right entry point. It is a very speculative play, so do not risk a lot of money on any rare earth stock. But if you want to play around with Molycorp, I'd suggest buying it on very bad days, best below $10.

There will be additional supply once the Malaysian plant starts to put out product, however, and if -- and that is a big "if" -- Molycorp is very lucky, elections in 2013 may even put off Lynas plans further. But that is not likely at all. Because as of now, Lynas licenses are only put on hold for one month. Much more likely is a scenario in which Lynas will have to make an additional commitment to safety, and will start its Malaysian refinery -- which could eventually put out 22,000 metric tones a year -- in one or two months (every month of delay costs Lynas $10 million) and make sure rare earth supply increases even further.

Disclosure: I am long MCP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.