Investing Around the Rare Earths Rough Patch

“Rare earth prices,” Bloomberg reports this morning, “are set to extend their decline from records this year.” They’re officially declaring one boom we’ve been following with some enthusiasm of late… busted.

As your friendly publisher, we’re glad Byron King pulled the trigger on 178% gains in Molycorp when he did. But we’re also keen to suggest there’s more to the story…

It’s tempting to draw a similar conclusion to Bloomberg when you examine the recent performance of REMX, the rare earth ETF:

Downward Trend of the Rare Earths ETF

Indeed, the most abundant rare earths, cerium and lanthanum, could plunge another 50% in price over the next year, according to an analysis by Hallgarten & Co. in New York.

The reality is a bit more complex.

Put simply, the easy money’s been made in rare earths. Yes, China controls 97% of world production. Yes, China has clamped down on exports. But China can’t stop the users of rare earths from looking for alternatives.

“If you think you can keep raising the prices for those materials and still keep your customers, you’re crazy,” says Jack Lifton, one of the foremost experts on rare earths. “The principal customer for rare earth metals is a global automotive industry using rare earth permanent magnets. That industry will engineer this stuff out.”

The recent rough patch for rare earth stocks was also fueled by a J.P. Morgan report on industry darling Molycorp, which we cited briefly a week ago Wednesday. In light of events today, it’s worth a closer look.

“What did the JP Morgan report say?” asks our own Byron King, who’s been onto the rare earths story since early 2008. “Not as much as you might think, really.

“The report noted that rare earth prices have fallen since July, which is hardly big news if you follow these things. The report also speculated that non-Chinese demand will fall in the near term, which is also hardly a state secret worthy of WikiLeaks.

“The big revelation was that JP Morgan cut its price target for Molycorp shares from the previous $105 per share estimate down to $66. Still, to me at least, that wasn’t ‘news,’ because I never really expected Molycorp shares to get much above the $60 range.”

Indeed, Byron recommended getting out of Molycorp at $52.52 on Jan. 12 of this year… good for a 178% gain in four months. This morning, the stock is below $34.

“Savvy investors are finished,” Byron writes by email this morning, “listening to stories about how some Canadian junior named XYZ Co., with four employees in Vancouver, has an ore body on the far side of nowhere.

“Even if the Vancouver company has eight employees, and one of them was a chemistry major 25 years ago before he became a stockbroker, the mineralogy and geology stories are nice, but won’t get you anywhere. Not anymore. Doesn’t impress anybody.

“Now, people want to hear about the metallurgy, at a graduate-level of chemistry, and not just arm waving. Investors want feasibility studies and engineering diagrams from serious laboratories.

“That is, people want to know that there’s real chemistry and real engineering going on. ‘Show me the test tubes!’”

And “show me the application,” we might add.

Addison Wiggin
for The Daily Reckoning