Molycorp’s Swirling Outlook
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the past few weeks, several competing global macroeconomic events have influenced the rare earth sector and the companies within it. Molycorp (NYSE: MCP), which is generally considered the standard-bearer for the sector, is likely to see a positive impact from last week’s Fed action, while the action out of Asia should have a mixed effect. Before committing capital in this space, it is critical to understand the changing backdrop against which such an investment would be made. Overall, Molycorp looks speculative in the near-term, but solid for those taking an extended view.
Positive Stimulus for Commodities
The recent actions of the ECB and the Federal Reserve have served as a positive catalyst for commodities. The ECB’s bond-buying program is expected to stimulate growth across Europe, notably in the construction sector, thus increasing demand. While this demand is centered in base metals, the overall impact for commodities has been positive. Additionally, aggressive action by two of the world’s most influential central banks is a strong sign of weakness in the economy. As investors look to precious metals as a safe haven, these prices rise as well.
The announcement of the latest round of quantitative easing serves as the final piece of the positive push for commodities. After the most recent U.S. jobs report was weak, the announcement of QE3 became a forgone conclusion for most market participants, but the extent of the policy shift that was ultimately announced is unprecedented. The Fed’s intention to pump $40 billion into the economy each month until the employment picture improves has real inflation implications. No matter how stimulative the move may be in the near-term, at some point inflation will become a serious force in the economy. High inflation expectations are bullish for commodities.
While the price drivers that impact rare earth materials tend to be somewhat varied from the general commodities market, the Fed action (as well as Asia, see below) drove the price of Molycorp much higher to end the week. Rare Element Resources (NYSEMKT: REE), Avalon Rare Metals Inc. (NYSEMKT: AVL) and Lynas Corporation Ltd. were all higher as well. Each of these competitors operates in the rare earth space and was positively impacted by QE3 and developing news coming out of Asia.
The Asian Connection
Over the weekend, China announced that it had slashed the number of rare earth mining permits being issued by 41%. The news comes only weeks after the Chinese government had announced that it was raising export quotas for the first time in seven years. The combined actions seem to be targeted at exerting tighter control over those companies involved in the rare earth business. The reduction in permits eases monitoring costs and means that remaining market participants have a significant enough stake that “cheating” is too high a risk. The move is likely to contract supply, which should have a positive impact on prices.
On the other hand, Lynas was just granted a temporary operating license for its Malaysian facility. Lynas Executive Chairman Nicholas Curtis referred to the license as a “significant milestone” for the company. He added that, "The TOL provides additional validation of the safety of Lynas' operations in Malaysia and supports the previous assessment by the world's pre-eminent radiation safety authority, the International Atomic Energy Agency, that the LAMP is safe and fully compliant with international standards."
Molycorp and Lynas are the two largest producers of rare earth materials outside of China, which controls roughly 95% of global supply. The entrance of two significant non-Chinese competitors is not considered bullish for rare earth commodity prices. Price depreciation on the commodity level has been a significant detractor from Molycorp’s share price over the past several months. Therefore, while the news out of China is positive, overall news is mixed at best. Lastly, the fact that Molycorp is nearly ready to bring its Colorado operation online is bullish for the company, but may have a negative impact on rare earth prices as more supply becomes available.
Trading Rare Earth
Molycorp remains the most established rare earth play in the sector and currently offers a mixed picture. Over the longer-term, there is no doubt that these vital minerals will stay in high demand and that prices will rise. In the shorter-term, however, the entrance of new players and the unpredictability of the Chinese government leave this as a speculative play. If you can stand the volatility, Molycorp should pay off over time, so buying selectively at dips is the way to play this stock. The fully risk averse are better finding other alternatives.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.