Sweet spot for rare-earth stocks

The correction is not yet complete, but some favorable buying opportunities may pop up soon in this high-risk, high-reward sector.

By MoneyShow.com Jun 6, 2011 11:35AM
By Tom Aspray, MoneyShow.com

Rare-earth stocks became the focus for many investors beginning late last year, although most shares had been on a tear for some time. All peaked in April when the reality of the Chinese rate hikes and ensuing economic slowdown dampened enthusiasm.

After an initial surge of negative sentiment after their peak, and now that they have declined further, some analysts are once again turning positive. Technically, rare-earth stocks look poised to make further new correction lows over the next few weeks, stopping out the recent buyers.

The leading stock in the sector, Molycorp (MCP), was hit by disappointing earnings in May, and that put further pressure on all stocks in the sector. From its highs in April at $79.16 to May lows at $55.82, MCP was down 29.4%. This likely discouraged investors who bought early in the year, but more recent buyers could also be due for shock.

One more drop below the May lows could take the leading stocks to my target buying zones, which are determined with a combination of Fibonacci and volatility band analysis. Such a decline is likely to coincide with another increase in bearish sentiment.

Chart Analysis: Molycorp is a $5 billion company in the development stage that focuses on the production and sale of rare earth oxides from western hemisphere sources. Its IPO came out last July at $14 per share. The weekly chart of MCP shows a two-week rally off the lows that should set the stage for a resumption of its downtrend this week.
  • There is initial support now at $57 and then at $55.82, which marks the recent lows
  • The 50% retracement support level is at $53 with the weekly uptrend, line a, in the $51.70 area
  • The lower weekly Starc band is at $49.90 with the 61.8% support level at $47
  • The weekly on-balance volume (OBV) did confirm the recent highs but is now just below its weighted moving average (WMA). It is well above support at line b. The daily OBV (not shown) is positive
  • There is first resistance now in the $65.50-$66.40 area and then in the $68 area
Rare Element Resources Ltd (REE) is a $500 million Canadian company whose heavy expenditures on a new project caused its nine-month loss to triple, as reported in mid May.
  • The weekly chart shows that REE has been in a broad range with resistance at $16.55-$17.92 and support at $9.90 (line c)
  • The 50% support level from last summer’s lows is at $9.50 with the weekly Starc- band at $8.60. The major 61.8% support stands at $7.62
  • Weekly OBV has seen some wide swings, but it did confirm the highs early in the year
  • Daily OBV and the chart pattern favor a further decline
  • There is initial resistance for REE in the $13 area with much stronger resistance at $14.90-$15

Avalon Rare Metals Inc. (AVL) is a $650 million Canadian company that focuses on mining rare-earth metals in Canada. No earnings estimates are available, but the company is reportedly losing money. There was a 14% increase in the number of shares sold short in May. In April, AVL had a high of $10.11, which reached the Starc+ band and the recent lows at $7.19 (tested Starc- band).
  • There is converging support on the weekly chart in the $5.40-$5.60 area. This corresponds to the weekly Starc- band, the 50% retracement support level, and the former resistance at line a
  • The weekly uptrend, line b, is in the $4.40 area
  • The weekly OBV did confirm the highs and it still holding above its rising weighted moving average. The daily OBV is just barely positive
  • Initial resistance is now at $7.80 with further resistance in the $8.60 area
The Market Vectors Rare Earth/Strategic Metals ETF (REMX) trades about 400,000 shares daily but has a limited price history, as it was launched only last October. Its three largest holdings are Iluka Resources (ILKAY), Lynas Corp. (LYSCF) and Molycorp.
  • REMX hit $28.91 in early April and has a recent low of $24.89. In March, REMX was as low as $20.19
  • The minor 50% retracement support is at $24.60 with the 61.8% level at $23.60
  • The daily OBV has traded in a narrow range for the past two months and is acting stronger than prices. The weekly OBV (not shown) did confirm the recent highs
  • There is first resistance for REMX in the $27.50-$28 area
What It Means: The correction in these rare earth stocks does not look complete and the sentiment analysis supports that view. Therefore, for those who want to establish a small position in this high-risk but potentially high-reward sector, there may be a good buying opportunity presented this month. If these stocks continue to move higher instead, I would recommend waiting for a new trend to develop before buying.

How to Profit: Go 50% long MCP at $51.86 and 50% long at $50.66 with a stop at $48.76 (risk of approx. 4.9%). On a move above $66.05, raise the stop to $54.86.

Go 50% long REE at $9.77 and 50% long at $9.29 with a stop at $8.83 (risk of approx. 7.3%). On a move above $13.20, raise the stop to $9.56.

Go 50% long AVL at $5.52 and 50% long at $5.28 with a stop at $4.97 (risk of approx. 8%). On a move above $7.55, raise the stop to $5.36.

I have no recommendation for REMX at this time.
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