Many investors are intrigued by rare earth metals, and that's perfectly understandable.
After all, they're exotic, they're used in a lot of high-end technologies and, as the name implies, they're somewhat hard to find.
But the truth is, if you simply throw money into the rare earth complex, you're likely to get burned.
So today, I'm going to blow the lid off this obscure sector and show you more adventurous investors exactly how to play it. And for those who have never even heard of rare earth metals, consider this a primer.
China's Market Monopoly
There are 17 rare earth metals. They have exotic and hard-to-pronounce names like yttrium and praseodymium. And they're mostly used in advanced technologies like smartphones, smart bombs and hybrid car batteries.
Now, despite their name, rare earth metals aren't that rare. They're just controlled - mainly by China.
You see, having realized the importance of these metals early on, China invested heavily in extraction technology. As a result, the country now controls more than 95% of the supply. That gives the country the power to manipulate the market by restricting its exports.
That's a big reason why the market is so volatile. Indeed, only the Chinese government really knows how much rare earth supply they have in inventory. And it's unlikely that they're telling the truth. So the information we have is spotty.
Now, what we do know is that demand for rare earth metals is about 136,000 tons per year, and it's expected to reach over 215,000 tons by the end of this decade. However, supply checks in at about 133,000 tons per year, leaving an immediate deficit of about 3,000 tons.
Given basic laws of supply and demand, there's definitely an opportunity to profit if you can get in at the right time. But be advised that this is a speculation that requires pure risk capital.
Having said that, here's a look at how to play the rare earth market…
Raring for a Rebound
While China did its best to restrict supplies, the global recession caused a major meltdown in rare earth prices. In doing so it took down one of the major players in the market: Molycorp (MCP).
Over the past two years, Molycorp has lost 90% of its value, tumbling from about $75 per share to its current level of $6.40. However, following that plunge, the stock is now trading below the company's book value of $7.66 per share.
And that's not all. Molycorp has also addressed several key issues, making changes at the highest levels of management, and charting a new and improved course. It's restructured its business, paring costs and moving away from unprofitable operations.
Revenue has been trending higher, as well, having climbed 73.32% in the first quarter to $146 million. That suggests the company is bouncing from the low point reached last year.
What I like most, though, is the high level of insider buying that Molycorp has seen over the past few months. Insider buying is a strong indicator, because nobody knows a business better than company insiders.
Still, before you go running to buy MCP shares, remember that the rare earth segment may only be worth playing for a couple of years. And even then, it's highly speculative.
That's why I'd suggest using LEAP options.
LEAP options are long-term options that expire in a year or longer. They give you exposure to the upside without requiring a ton of capital to be tied up, hence reducing your dollar risk.
I would recommend looking at the MCP January 2015 $10 calls, which are currently trading around $1.40. This would give you exposure to any upside run and cost you less than 25% of the current share price.
And "the chase" continues,
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.