Rare earth divides investor sentiment

The price of rare earth has shot up exponentially in recent months as speculators have been accused of targeting the industry for huge return. Rare earths are a collection of 17 elements with exotic-sounding names like terbium, europium and lutetium, but are key to everyday hi-tech applications such as flat-screen monitors, electric car batteries, green technologies like wind turbines and missiles. Quoted rare earth miners have seen valuations surge yet some investors remain skeptical and short interest is close to record highs. We look at Molycorp Inc. (NYSE:MCP) and Rare Element Resources (CVE:RES).

China dominates the rare earth market with over 90% of global production, and the Wall Street Journal and the WSJ hasJournal has reported accusations that China could use its quota system and new taxes to stockpile reserves to squeeze global supply. Mining rare earth metals is damaging to the environment. Known in China as “industrial vitamins” the new Chinese export tax distinguishes between light and heavy rare earths by their effect on the environment. Regardless, since the beginning of this year, average rare earth prices have doubled in China. The outlook for rare earth miners outside of China depends in part on Chinese export policy and on forecasts for Japanese demand, which has been impacted by the terrible earthquake according to Wall Street JournalSJ reports.

US listed Molycorp Inc. focuses on the most commercially in-demand metals. The company boasts a market cap USD 3.7bn on annual turnover of only USD 35m, driven by eye watering growth expectations. Reuters reported comments by the CEO at a conference in Toronto that prices are "significantly higher than we anticipated" and that Japan's quake didn't impact sales in that country. The shares have trebled since August last year, yet short interest has surged, peaking in late February at 9% of total shares outstanding on loan, before shorts covered positions to 6.7%. This represents over 55% of the available supply of shares that can be borrowed.

Long only investors who lend, our proxy for institutional ownership, have followed the share price and trebled holdings since August. It should be noted that Molycorp has a convertible bond in issue and may be subject to arbitrage, which can inflate the amount of stock on loan.

Rare Element Resources is a small cap miner involved in three rare earth and gold projects in North America, though its primary focus is developing the Bear Lodge project just outside of Sundance in Wyoming.The shares quadrupled in 2010 and at CAD 13 are over 25% off the January high. Short interest has spiked from nothing in January this year to a high of 6% of total shares outstanding on loan, which represents over 85% of the lendable supply, meaning it would be very hard to short more of this company. Yet this is another company which that divides investor opinion, as institutional investors who lend have aggressively increased their holdings.

We are not able to see short interest in Baotou Steel Rare-Earth Hi-Tech Co, China’s leading rare earth producer or China Gengsheng Minerals Corp. Xinhua newswire reports that the newly introduced export tax will increase production costs. Yet share prices of miners across the industry continue to be boosted by exuberant demand, running the risk of forming dangerous bubbles.