Rare Earths – short sellers anticipate further correction; Longs build holdings

 China controls 95% of the world’s supply of rare earth elements used in the manufacture of essential high tech equipment ranging from solar panels to flat screen TVs, and missiles to lasers. Bloomberg reports that the nation has tightened controls on mining and export quotas, driving rare earth prices to double over the past two weeks. In April, we reported split sentiment between long and short investors in the quoted rare earth mining companies outside of China. Since the April correction, the share prices of Molycorp Inc, Avalon Rare Metals Inc. and Rare Elements have collapsed by around a third. Longs continue to show faith, yet short sellers believe there is more to come and have continued to build positions.

Shares in US listed Molycorp Inc. (NYSE:MCP), have fallen by nearly 40% since finally peaking in early May. Short interest has more than doubled to 8% of total shares outstanding on loan over the past month. Yet contrasting investor sentiment continues as institutional ownership of large funds who lend has increased by 30% in the last month to 12% of the total shares. This stock does have convertible bonds in issue which could inflate short interest, but the most short interest movement in this stock appears to be directional shorting.

Canada’s Avalon Rare metals Inc. (AMEX:AVL), has seen its shares fall by a third since April after reaching an annual high just short of CAD 10. Short sellers have not been deterred as short interest has reached a fresh high of 11% of total shares outstanding. With more than 80% of the lendable supply currently out on loan, the stock is expensive and hard to borrow. On the long side, institutional ownership of funds who lend has quadrupled since the start of the year. This stock also has a convertible bond in issue, but recent short interest activity appears to be directional.

The share price rally in Rare Element Resources Ltd. (CVE:RES), a North American small-cap miner, peaked in April, whereupon the shares have fallen by 35%. Short interest has continued to climb reaching an annual high of 15%. However, some recent short covering has brought down current levels to 13% of total shares outstanding on loan.

Bottom line:

The world is clamoring for alternative supply following the recent actions by China. Despite April’s share price correction, short sellers have continued to build positions, apparently believing these miners are still overvalued. Despite this, institutional investors have taken a long-term view in acknowledgment that there will continue to be heightened demand for the supply of rare earth from outside of China.