This Rare Earth Leader is Now Dirt Cheap

On Tuesday, I brought my Scarcity & Real Wealth subscribers some important news, some of it bad, some of it good.

The bad news: rare earth miner Molycorp (NYSE: MCP), one of my favorite stocks in this exciting sector, was down 22% on Tuesday, Sept. 20.

Since then, it’s fallen another 10%.

So what precipitated the knee-jerk reaction that erased one-fifth of the firm’s market capitalization?

Did China (which has a 97% strangle-hold on the world’s rare earth production) have a change of heart and altruistically start handing out supplies? Did global manufacturers suddenly stumble on a miracle alternative to irreplaceable metals like neodymium? Did Molycorp’s board abscond to South America with a few suitcases of shareholder capital?

Fortunately, it was nothing that drastic. The hammer fell because of a routine downgrade from a JP Morgan mining analyst who cut his target price on MCP from $105 to $66. That’s the most bearish outlook on The Street. The Wall Street community recently had an average target of $94, more than double where the stock is trading today.

So there was essentially no fundamental reason for the stock’s dive. An analyst simply felt that rare earth prices had simply shot up too much in the past year and were due for a pullback.

So what does this mean? Well, that’s the good news…

The good news is you may not get another chance to own Molycorp at these levels. Even if this bearish analyst is right, his price target of $66 still represents a gain of 83% from these levels.

Ordinarily, I don’t spend time talking about analysts’ comments. But in this case since the downgrade itself specifically triggered the selloff, I should note that the cautious outlook hinged on moderating rare earth oxide (REO) spot prices.

For example, Lanthanum (most commonly used in hybrid car batteries) has slipped about 36% from its July peak. But a pullback in the overheated metal is hardly a surprise. A decade ago, lanthanum sold for less than $1 per kilogram. By 2007, it and other “light” rare earth metals like cerium changed hands for around $3 per kilogram.

But from that point until a couple months ago, prices skyrocketed all the way to $130 per kilo — a jaw-dropping 4,200% surge. Many metals had soared more than 10-fold during the prior year alone, so letting off some steam is actually healthy.

I want to repeat something I said during my last update to Scarcity & Real Wealth readers on Molycorp: “Prices will level off and quite possibly pull back once more production capacity comes online.”

We’re starting to see that now, as the market prices in the expectation of additional future supplies streaming in from Molycorp’s Mountain Pass Site in California and Lynas Corp’s (OTC: LYSCF.PK) Mount Weld mine in Western Australia.

But I’m looking forward to it. Because the ramping up of production is exactly why Molycorp will deliver astronomical growth rates during the next few years (even if prices continue to slide). The analyst who splashed cold water on the party just cut his earnings outlook to $1.75 per share (from $2.44) in 2011, $3.15 in 2012, and $11.20 in 2013.

That lowered forecast “only” points to a 540% explosion in the bottom line in the next few years. Most companies would kill for that. And remember, this comes from the most bearish analyst who tracks the stock.

We’re already starting to see the company harness its potential. Mountain Pass sold 829 metric tons of REO last quarter, a 212% increase compared with the same period in 2010. Better still, prices jumped nearly 1,000%, from $7.16 per kilo to $72.80. And they would have been even higher, but much of the sales were under a contract with a fixed price ceiling.

Products not covered by the fixed-price contract went for $105 per kilo — and I’m happy to report the contract has just been renegotiated.

As it stands, Molycorp’s latest quarterly revenue leapt to $100 million from less than $2 million a year ago. And that’s just from sifting through old stockpiles. Soon, production won’t be measured by the hundreds of tons, or even the thousands of tons — but by the tens of thousands.

Once expansion is complete, Mountain Pass is expected to give up 40,000 tons of REO annually.

Risks to Consider: It’s always conceivable that REO prices could completely crash, although I consider this extremely unlikely.

Demand for these crucial 21st-century building blocks (which can be found in everything from iPads to water treatment plants) is likely to climb from 127,000 metric tons to 177,000 worldwide during the next three years. We can’t rely on shipments from China to make up that 50,000 ton gap.

In fact, I believe China will ultimately become a net buyer rather than a net seller.

That’s why Molycorp’s CEO Mark Smith testified before Congress Wednesday regarding the implications of this alarming shortfall. And it’s why manufacturing hubs like South Korea have just announced plans to begin hoarding more supplies.

Action to Take –> The powerful macro trends that led me to this stock in the first place haven’t changed a bit since last summer. Meanwhile, shares of Molycorp have been cut drastically, setting up a prime buying opportunity for anyone who missed the sprint up to $80.

According to Morgan Stanley, the market is pricing Molycorp’s REO assets at less than $28 per kilogram (versus a current spot price of $111). In other words, REO prices could tumble in half and the stock would still be a steal at these levels.

Unless and until the big picture changes (which is unlikely), I remain an enthusiastic buyer. In fact, I bought another 25 shares for my real-money Scarcity & Real Wealth Portfolio during afternoon trading on Thursday, Sept. 22. I always give my readers advance notice of a transaction. You, of course, are free to accumulate shares immediately.