Time to dig in to rare-earth stocks
With many driven close to their 52-week lows, here's what to watch for during the second half of 2012.
Luisa Moreno at Jacob Securities in Toronto explains that performance-wise, rare-earth equities have been following the global trend for commodity equities across the board.
For example, the Market Vectors Rare Earth/Strategic Metals ETF (REMX) is down just over 10% this year (as of June 13), while Molycorp (MCP) is down 16% year to date, after a 47% tumble in 2011. Avalon Rare Metals (AVL) has fallen more than 40% in 2012 after a 47% drop in 2011.
In comparison, Toronto's S&P/TSX Venture exchange is down 16% so far in 2012, while the main index, the S&P/TSX Composite, has fallen 3.8%.
Rare-earth prices have also been volatile, with neodymium oxide rising more than 82% in early 2011 due to speculation, but falling around 70% in the six months to April, Chi Weishan, a researcher at Shanghai Metals Market, said via The China Post.
"Then they all of a sudden collapsed significantly because I think there was a lot of stockpiling as well, before that, and with the slowdown in the economy, less demand," says Moreno, although she says prices are starting to level out.
Rare-earth elements, Moreno says, are sold to produce bulbs for cars, iPads, and cellphones, for example. If the economy picks up slightly, she sees demand coming back as these elements are not easy to replace.
"I think the prices are approaching levels which are economic again for many of the industries that they're used and so I would expect, in the second half, for demand to pick up and prices to stabilize a little bit more, but that may not have an effect on company stocks," she says.
According to reports, Dahlman Rose & Co recently said in a note to clients that minor changes in China's rare earths sector should support prices over the medium to long term, despite a fall-off last year.
"It is possible that prices (will) decline further in 2013 when two new sources of supply commence, but over the near-term, we expect to hear of further project delays and the possibility that numerous development-stage companies are giving up their development plans," analysts say.
In this uncertain environment, investors should be looking to companies that have favorable rare earth distribution, including most of the critical metals such as neodymium and praseodymium, and a reasonable amount of the heavy rare earths, combined with good distribution and a joint venture partner to develop these very expensive projects, Moreno says.
Moreno points to Matamec Explorations (MAT.V), which she says has performed poorly, but would be one stock to look at in this regard.
In December, Matamec signed a non-binding Memorandum of Understanding with Toyota Tsusho Corp., which was interested in the Kipawa Heavy Rare Earths Deposit in order to secure a heavy rare earth element supply for the production and marketing of hybrid and electric vehicles. Moreno is looking for the company to sign a definitive JV agreement soon.
Another name to watch out for in the next 12 months, says Moreno, is Tasman Metals (TAS) which has good management and 50% of its deposit in heavy rare earths.
In terms of potential M&A activity in the sector, Moreno says that Molycorp is in a very good position, having officially closed its acquisition of Canadian-based Neo Material Technologies Inc. (NEM.TO) earlier this week.
"We believe that this acquisition is a win-win situation," Byron Capital Markets analyst Jon Hykawy recently wrote in a note to clients, as reported by Reuters. "Not only should it significantly improve Molycorp's earnings but it also de-risks the start-up of Molycorp's own (processing) facility."
Moreno notes that Credit Suisse and Morgan Stanley provided a credit facility to Molycorp for the purchase of Neo Material and is likely still left with extra cash with which it may find a heavy rare-earth deposit.
"Lynas (LYC.AX) might have a similar strategy as Molycorp: Either, you know, acquire a second mine, perhaps in Africa and try to ramp up production there, since the Malaysian situation's a bit complicated, or even go vertically," she adds.
Although Molycorp and Lynas do have plans to come to production, one factor that Moreno doesn't see changing significantly this year is China’s role as producer of 95% of the world's rare-earth metals.
"Especially as far as the heavy rare earth elements, they will still continue being the largest supplier, more than 90% consistently every year for a few years, because Lynas and Molycorp really don't have the heavy elements -- and yes, Molycorp has Neo Materials, but those are factories that are in China and . . . they will be subjected to export quotas."
China announced additional rare earth export quotas last month, according to a recent report, but it has gradually tightened its export restrictions over the last few years, prompting a challenge by several other countries.
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