Time to Move on Rare Earths

by Carl Delfeld, Investment U Senior Analyst
Thursday, May 31, 2012
Carl Delfeld

I just published a 50-page special report on China aimed at institutional investors. An Inconvenient Truth About China: Seven Troubling Trends (www.ChinaSkeptic.com) describes how its semi-market state capitalism model is in need of significant reform.

But no matter what happens with China’s economy, one truth will remain. The country has a lot of leverage over rare earth production and prices. It produces 90% and controls 95% of the export market for the 17 metals considered “rare earths.”

This is a big deal because many emerging industries rely on these rare earth metals and elements. A Toyota Prius contains about 10 pounds of lanthanum. Smartphones, tablets, night vision goggles, jet engines, giant wind turbines, GPS, fiber optics and missiles are just a few other examples.

China made headlines in late 2010 when it suspended exports to Japan as negotiating leverage during a territorial dispute with Japan. The tactics led to alarm and a surge in rare earth metals and stocks through the summer of 2011.

Since then, you may have noticed that rare earths largely disappeared from headlines and stock prices came back to earth. Meanwhile, the industrial uses of these elements increased, while there are also indications that the high prices during 2011 led to a ramp-up of mining activity.

Take Advantage of the Pullback

Weighing all this, I believe it’s time to take advantage of this sharp pullback and make a value-driven move on rare earth stocks. My top pick is Denver-based Molycorp (NYSE: MCP), whose stock is down 66% in the last year.

Molycorp, founded in 1946, mines rare earth minerals and elements at its fully integrated mine in California and runs processing facilities in Arizona and Estonia. In addition to producing rare earth oxides at its rare earth mine and processing facility at Mountain Pass, California, the company produces rare earth metals, rare earth alloys (such as neodymium iron boron and samarium cobalt alloys) and rare metals such as niobium and tantalum.

In 2011, the company announced a partnership to produce high tech magnets in Japan. A bigger deal was the acquisition of rare earth producer Neo Material Technologies for $1.3 billion announced in March of 2012. This deal is significant because the 2011 results of the combined companies on a pro forma basis show a tripling of revenue and gross profits, while the holding of Molycorp shareholders will be diluted by only about 15%.

Looking forward, the combined Molycorp and Neo Materials is forecast to produce $1 billion of revenue and $3.80 per share of net income in 2013 when the merger is fully completed. If the combined enterprise gets into the ballpark of these projections, the impact on its share price should be sizable.

It was during 2011 that Molycorp’s rare earth business exploded with revenue, going from $35 million in 2010 to $362 million leading to an EPS of $1.27. The company also posted a solid first quarter in 2012, marginally beating consensus earnings per share estimates with quarterly revenue up 222.5% year over year.

The combination of the sharp pullback in share price, the acquisition of Neo Material Technologies and the recent reassuring earnings report are all catalysts pointing to a sharp rebound for Molycorp. I also noticed an uptrend for the stock since the earnings were released.

If you prefer a broader shotgun approach, take a look at the Market Vectors Rare Earth/Strategic Metals ETF (NYSE: REMX). It’s a basket of 30 companies from around the world that are engaged in mining, refining and manufacturing of rare earth strategic metals.

This ETF offers a 5.4% dividend yield, and roughly 60% of its holdings are small- and mid-cap stocks from all over the world – but mainly concentrated in the United States and Australia. Surprisingly, only 10% are based in China. Launched in late October 2010, it caught some of the rare metal surge through the summer of 2011, but ended up down 39% for the year.

Though you should expect some volatility, I recommend pairing a small stake in MCP and REMX to take advantage of their out-of-favor status while you have the chance.

Good Investing,

Carl Delfeld


EUROBONDS: Primary More Active On Stronger Market Tone

By Sarka Halas


LONDON (Dow Jones)–European corporate and bank issuers took advantage of stronger market sentiment Thursday, continuing the activity seen earlier this week in the primary bond market, while the costs of insuring European corporate debt against default fell.

Earlier this week, markets were roiled on the back of developments in Spain. After a proposed EUR19 billion Madrid-backed bailout plan for Bankia SA, investors feared the costs of restructuring Spanish banks would prove too much for the country, already battling stringent fiscal targets and a sliding economy.

Sentiment was boosted Thursday by data showing that euro-zone inflation slowed more than expected in May to 2.4% from 2.6% in April, giving the European Central Bank more flexibility in terms of loosening its monetary stance.

In the primary market, French construction materials group Compagnie de Saint-Gobain SA (SGO.FR) is to price its EUR750 million, nine-year bond at 200 basis points over midswaps. This is tighter than initial guidance in the area of 205 basis points over midswaps.

Also in France, Aeroports de Paris has priced its two-part, senior unsecured bond. Pricing of the EUR300 million, seven-year bond was at 97 basis points over midswaps, and pricing on the EUR500 million, 12-year bond was 135 basis points over midswaps; both are tighter than initial price guidance.

In the sterling-denominated market, U.K. lender Clydesdale Bank PLC is to price a two-part covered bond, with the GBP400 million, 3-year bond at 170 basis points over the three-month Libor, which is tighter than initial price guidance of 170-175 basis points, and its GBP700 million 14-year fixed-rate tranche at 270 basis points over the 5% 2025 gilt, also tighter than initial price guidance of 270-275 basis points over gilts.

German lender Deutsche Bank AG (DB) has priced its EUR500 million, 10-year covered bond at 12 basis points over midswaps, having been revised tighter from 14 basis points.

Norway’s state-owned Kommunalbanken has set pricing on its dollar-denominated, benchmark-sized, five-year bond in the area of 50 basis points over midswaps.

The cost of insuring corporate debt against default fell Thursday as markets rebounded on the back of stronger than expected euro zone inflation data after a torrid day’s trading Wednesday.

At 1200 GMT, the iTraxx Europe index, which comprises 125 high-grade borrowers, 25 of which are banks and insurers, widened to 176/177 basis points, one basis point tighter from Tuesday’s close, while the Crossover index of 40 mostly sub-investment-grade European corporate borrowers was four basis points tighter at 714/717 basis points.

-By Sarka Halas, Dow Jones Newswires; +44 (0) 207 842 9236; sarka.halasova@dowjones.com

(Ben Edwards in London contributed to this report)

EU’s Van Rompuy: Solving Debt Crisis Key To Sustaining EU Power

LONDON (Dow Jones)–The EU needs to solve the euro zone debt crisis if it is to keep its status as a global power, EU Council President Herman van Rompuy said Thursday.

“Restoring the euro zone’s stability is indispensable for us to punch our full weight at the global stage,” van Rompuy said in a speech to the Royal Institute of International Affairs.

He stressed the importance of higher growth in solving the crisis, but concentrated on the need for a higher potential growth rate than for short-term stimulus policies.

“Even if it is perfectly normal that ‘mature’ economies grow more slowly than emerging ones, a potential growth of 1.5% is simply too low,” van Rompuy said. “We must focus therefore internally as much on growth as on stability.”

Van Rompuy’s comments are consistent with an increasingly broad drift towards prioritizing growth in the role of the euro crisis, and away from a narrow focus on reducing budget deficits.

Separately, van Rompuy criticized China and Russia for blocking firmer UN Security Council action against Syria in response to repeated breaches of the ceasefire brokered by special envoy Kofi Annan, the most flagrant of which happened at the weekend when over 90 civilians were killed in the town of Houla. A number of western nations have expelled Syrian diplomats as a result of the massacre.

“Russia and China’s position on the Syrian uprising shows that they cling to the past,” van Rompuy said. “History is on the side of democracy.”

He said he would raise the Syrian issue with Russian President Vladimir Putin in a meeting at the weekend, but played down suggestions that the EU should adopt a less cooperative stance with Russia as a result of that, or as a result of widespread abuses during parliamentary and presidential elections in Russia in the last six months.

“We have different views on the implementation of basic values,” van Rompuy said in answer to audience questions.

Van Rompuy said he also expected to discuss the issue of the Eurasian Economic Union–a new customs union promoted by Putin and explicitly modeled on the EU–at the weekend meeting.

-By Geoffrey T. Smith, Dow Jones Newswires; +44 758 427 1612; geoffrey.smith:@dowjones.com

IMF’s Shafik Welcomes Euro Area Banking Union Proposal

BRUSSELS (Dow Jones)–The International Monetary Fund Thursday welcomed a European Commission proposal for the creation of a banking union that would include an EU bank-deposit guarantee and a common bank resolution framework, as well as a possible rescue fund for the currency area that could lend directly to banks rather than through sovereigns.

The Fund’s deputy managing director, Nemat Shafik, made the comments at an economics conference in Brussels.

Shafik said: “Yesterday’s proposals [by the European Commission]for a banking union are a welcome step,” adding that it supported a “common pool [for bank recapitalization] independent of national resources, sooner rather than later.”

The senior IMF official said fiscal consolidation targets for 2012 in euro area countries were largely appropriate but warned that “fiscal consolidation can hurt growth when a number of countries try to do it simultaneously.”

She called on the European Commission to give some countries more flexibility in meeting their targets. The Commission has said it would consider doing this for Spain with the country possibly getting an additional year to meet tough deficit targets.

“In a few countries, nominal targets for deficit reduction are too pro-cyclical and need to be adjusted, or at least expressed in structural terms,” Shafik said, adding that another consideration could be to specify countries’ deficit goals in cyclically-adjusted rather than nominal terms.

-By Matina Stevis, Dow Jones Newswires; 003227411483; matina.stevis@dowjones.com; Twitter: @MatinaStevis

ESM Won’t Directly Recapitalize Banks (losers at the command are just that. BIG losers!)

BRUSSELS — The current plan for the European Stability Mechanism, the EU’s permanent bailout vehicle, does not include direct recapitalization of banks, a spokesman for the bloc’s executive arm said Thursday.

“You have to distinguish between things; some things are possible now. some for the future,” said Amadeu Altafaj Tardio, spokesman for Economic Affairs Commissioner Olli Rehn.

“With the ESM, as it is, when it comes into force it won’t cover the direct recapitalization of banks with a direct injections of funds from the ESM,” he told reporters in response to a question about the fund’s role.

On Wednesday, the European Commission issued a report on the region’s financial and debt crisis that called for allowing the fund, expected to become operational in July, to directly recapitalize ailing banks.

The ESM treaty is being voted on in Ireland today, while grassroots groups in Germany are pushing their courts to review whether the ESM treaty infringes constitutional rights ahead of the country approving it.

In addition, the commission said the 17 countries that use the euro should consider setting up a “banking union” that allows them to share the burden of bank failures. After announcing some plans yesterday, a spokeswoman said EU commissioners would discuss further elements of the plan at their weekly meeting on June 6.

“For some now we’ve been setting up different bricks in the building project, we’ve set several ideas on the table before the legislators,” she said. “Our proposal is not about the current crisis, it’s about avoiding crises in the future.”

Proposals would then pass to the European Parliament and EU leaders for approval.

-By Frances Robinson, Dow Jones Newswires; +32 2 741 1486; frances.robinson@dowjones.com

UPDATE: Fed’s Pianalto Supports Accommodative Fed Policy

By Michael S. Derby 

NEW YORK (Dow Jones)–It will take as much as half a decade for the U.S. economy to get back to its natural unemployment rate of around 6% in an economic environment that will require strong Federal Reserve support, a U.S. central bank official said Thursday.

“My current assessment is that the real economy continues to show considerable cyclical weakness,” Federal Reserve Bank of Cleveland President Sandra Pianalto said. “This assessment, along with my outlook for moderate growth and subdued inflation, calls for today’s highly accommodative monetary policy.”

With the economy likely to grow by 2.5% this year and by 3% in 2013 and 2014, “it could take as long as four to five years for the unemployment rate to fall to the 6 percent rate I judge to be consistent with maximum employment,” the official said. She sees inflation staying around the Fed’s 2% target through 2014.

“My outlook for both economic activity and inflation relies on monetary policy remaining accommodative,” Pianalto said.

The central banker currently holds a voting slot on the monetary policy setting Federal Open Market Committee. Her comments came from the text of a speech at the Association for Business Economics Industry Conference in Cleveland.

She spoke in the wake of two separate speeches Wednesday in which the president of the New York Fed, William Dudley, suggested additional Fed support of the economy isn’t needed, while the Boston Fed’s Eric Rosengren suggested that it is. Fed officials, as well as many in financial markets, expect the economy to continue to grow, but Europe’s troubles and U.S. taxation and spending issues are clouding the outlook.

In her speech, Pianalto reminded the audience that she supports the current Fed outlook, which projects short-term interest rates will stay near zero percent until late 2014. But she offered some guidance on how to interpret that outlook, saying “this date is not a commitment.” Pianalto said “if there is a substantial change in the economic outlook, or risks to the outlook, then the guidance would change appropriately.”

Pianalto spent a notable amount of her speech on the topic of her bank’s annual report, which was also released Thursday. She sought to make sense of still woeful state of the labor market, and determine how much of the current troubles are structural, and how much of it is just the result of weak economic activity. She favors the latter explanation.

“There are about three people looking for work for every job opening,” the official said. “The only long-run solution to the unemployment problem is to increase the number of job openings through more growth in overall economic activity,” she said, adding the facts of the job market “make a lot of today’s unemployment look more cyclical than structural to me, although persistent cyclical unemployment runs the risk of translating into structural unemployment through the loss of skills.”

   -By Michael S. Derby; Dow Jones Newswires, 212-416-2214 

DATA SNAP: US 1Q GDP Revised Down To 1.9% Growth Rate, Profits Up

By Tom Barkley and Jeffrey Sparshott 

WASHINGTON (Dow Jones)–The U.S. economy slowed more than initially thought in the first quarter amid smaller gains in consumption and inventories, while corporate profits picked up.

Gross domestic product increased at a 1.9% annual rate from January through March, the Commerce Department said Thursday. In its original report a month ago, the department estimated an increase of 2.2% in first-quarter GDP, the broadest measure of all the goods and services produced in an economy.

Still, companies registered their biggest quarterly gain in profits since the end of 2009. Corporate profits–after tax and unadjusted for inventories and capital consumption–increased at an 11.7% annual rate from the previous quarter. Profits were up 14.8% year on year in the first quarter, Commerce said.

The economy has cooled off since expanding at the fastest pace in a year and a half in the final quarter of 2011, with a 3.0% growth rate. But the fourth-quarter acceleration was driven partly by companies aggressively restocking inventories to catch up with demand.

Thursday’s report showed that the inventory buildup was even less than expected in the first quarter, with the contribution to GDP falling to just 0.2 percentage point from 0.6 percentage point.

Consumer spending was also slightly weaker than expected, rising 2.7% instead of 2.9% as initially thought. Still, that marked the biggest gain in consumption since the fourth quarter of 2010.

Meanwhile, government spending continued to weigh on the recovery, with the drop revised down to 3.9% from 3.0%, mostly on the back of weakening state and local finances.

An unexpected pickup in business spending helped to partially offset downward revisions elsewhere, with investment in areas like software and industrial equipment rising 1.9%. Nonresidential fixed investment was initially estimated to have declined 2.1% in the first quarter.

Last month, Federal Reserve lifted its forecast on growth for this year, to between 2.4% and 2.9%. But Fed Chairman Ben Bernanke warned after the policy-setting meeting that “it’s a little premature to declare victory.”

One lingering uncertainty is whether the moderate pace of growth would be enough to bring down unemployment and spur demand. Friday’s monthly employment report is expected to show a modest pickup in job creation, with the addition of 155,000 nonfarm payrolls in May. But the unemployment rate is expected to remain at 8.1%.

Another concern is the recent flare-up in inflation, though the most recent data have largely validated the Fed’s view that the pressures would be temporary, as oil prices have receded from their highs.

The GDP report continued to show a buildup in inflationary pressures in the first quarter. The price index for personal consumption increased 2.4%, as previously estimated. That was double the rate of the fourth quarter.

The closely watched core PCE gauge, which excludes volatile food and energy prices, remained up 2.1%. That was up from the 1.3% rise in the fourth quarter.

The Commerce Department’s release on GDP can be found at http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.

-By Tom Barkley and Jeffrey Sparshott, Dow Jones Newswires; 202-862-9275; tom.barkley@dowjones.com