Efficient Market Theory Cannot Apply To Molycorp (MCP, AVL, REE, REMX)

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Molycorp, Inc. (NYSE: MCP) is being punished today on news which some would argue is very mixed.  J.P. Morgan decided to lower its price target and earnings estimates for Molycorp.  The new target is down at $39.00 versus a prior target of $57.00 and 2012 estimates were cut to $2.78 EPS from $4.50 per share.

What is interesting about the news is that China has been reported as cutting its export quotas for the year ahead. The problem is that the levels are still higher than what many investors were expecting.  Further increased production targets from both Lynas (Australia) and Molycorp are also expected to weigh on prices of rare earths.  It is currently overlooked that Molycorp’s production is mostly booked up for a year (and more from some customers) at this point.

Avalon Rare Earth Metals Inc. (AMEX: AVL) s down “only” 3.1% at $2.50 and Rare Element Resources Ltd. (AMEX: REE) is down 6% at $3.41 on the day with a new 52-week low.  The Market Vectors Rare Earth/Strategic Metals ETF (NYSE: REMX) is down only 1.2% a $15.01 and its 52-week range is $13.82 to $28.91.

Based upon its valuations, we recently provided a full outlook for 2012 in Molycorp because its stock has been sold down so much from highs.  The short version is that the stock is attractive, but there are some serious caveats.  What price Molycorp truly bottoms out at is truly guesswork.

Investors need to understand one key issue about Molycorp.  It is a euphoria or hypochondriac when it comes to its stock.  China has proven to be untrustworthy when it comes to forecasting output versus saber-rattling over what it is willing to export (and at what price).  If China comes back out and says in the first quarter that its rare earth supply quotas are being absorbed too rapidly and that it will not allow exports later in the year, then traders and investors will not bother conducting even a forward P/E analysis in Molycorp shares.  They will just start loading up.

The other side of the coin is that China could cheat on its export quotas.  It would be no surprise, and there is some history to suggest that it could happen.  Does each nation inside OPEC actually stop every barrel of oil exports when they hit the OPEC-mandated quotas?  Sometimes yes, many times no.  When news comes out (if it does) that Chinese companies have sold more rare earths than what was expected, it is only normal to expect investors to sell the shares off without conducting any analysis.

Molycorp is now down over 8% and share hit a 52-week low after breaking under $25.50.  This is the hypochondriac version of the stock… bad headlines kill the stock, regardless of what should have already been priced in.  The market has known for some time that China is not going to be as strict as investors once feared.  Molycorp has also lost literally two-thirds of its value from the peak of $79.00. 

It is our take that the market has proven over and over in 2011 that it is just not capable of pricing in good news or bad news any longer.  That is exponentially the case for a company in rare earths.  Still, today’s news should have been fairly easy to anticipate.

JON C. OGG