Contributor Since 2010
News out of China has propped up slumping rare earth stocks, which are now likely to continue 5%-10% higher, presenting short-term buy opportunities for investors who don't mind the risk.
Rare earth metal stocks bucked the market's trend on Wednesday by closing sharply higher on heavy volume. The news out of China sparked a rally in what has been a severely depressed market.
The Chinese government's warning that rare earth resources in the major mining areas were already depleted was thought by some to be just an excuse to support the nation's restriction on exports.
Certainly, those who are expecting the Chinese economy to suffer a "hard landing" have made the case that the rare earth stocks are overpriced. I have felt for several months that the Chinese government would do whatever it takes to turn the economy around, and the recent actions suggest China is starting to get serious about that initiative.
Even if there is no real shortage of rare earth elements, a resurgence in China's economy would be positive for these stocks, which have been in a year-long bear market. The sharp increase in volume is a positive sign, and now is the time to target new buy levels.
Chart Analysis: Molycorp Inc. (MCP) is a $2.16 billion development company that produces and sells rare earth oxides. The weekly chart (left panel) shows that MCP made a high of $79.16 in May 2010.
The daily chart for MCP (right panel) shows that the upper boundary of the trading range at $22.40, line c, was tested on Wednesday.
Avalon Rare Metals Inc. (AVL) is a $168 million Canadian rare earth development and exploration company. AVL peaked at $10.11 in April 2011 and recently hit a low of $1.36.
Rare Element Resources Ltd. (REE) is a $228 million company that acquires and explores mineral assets in both Canada and the US. The stock's rally on Wednesday broke through the daily downtrend, line e.
What It Means: A turnaround in the rare earth metals could be significant for the Chinese stock market as well as some of the other emerging markets. Those who have traded these markets, however, know that they are not for the faint-hearted and are quite volatile.
There is a good chance that after Wednesday's rally, the rare earth stocks will add another 5%-10% on the upside before they consolidate. If they instead give back a bit of their recent gains, it should provide a reasonable-but not a low-risk-entry point.
I favor Rare Element Resources Ltd. (REE) above the others, followed then by Molycorp (MCP), and would avoid Avalon Rare Metals (AVL) for now.
How to Profit: For Molycorp Inc. (MCP), go 50% long at $21.44 and 50% long at $20.66 with a stop at $19.58 (risk of approx. 7%). Cancel the order if $24.30 is hit first.
For Rare Element Resources Ltd. (REE), go 50% long at $4.54 and 50% long at $4.14 with a stop at $3.92 (risk of approx. 9.7%). Cancel the order if $6.30 is hit first.