1 Volatile Stock That Could Be a Rare Gem

Rare earth metal stocks enjoyed a healthy pop recently, following news from China that suggested further export constraints on Chinese producers. Molycorp (NYS: MCP) , in particular, saw an especially strong surge. It's worth noting, however, that it had been trading near the bottom of its 52-week range. Still, despite a mixed bag of factors, Molycorp may just be poised for further recovery.

The Manchurian Element
As I explained in a recent article, China controls the vast majority of the planet's rare earth resources. Other countries think it's not fair that China keeps all the good rare earth for itself, so they all got together in March to complain to the teacher -- I mean the WTO -- about how China wasn't sharing and caring. China's response came in June: It basically told the other countries exactly where they could shove their complaints.

The "Countries That Are Not China" -- let's call them the CTANC -- assert that China violates free trade rules by limiting rare earth exports, which, in turn, hikes prices and gives Chinese buyers an unfair advantage. China retorts that its production restrictions are designed to mitigate the environmental damage that mining causes. The CTANC rejoin shrilly that this is just an excuse. Interesting how the CTANC so often demand that China improve its environmental performance, until such time as the trade-off pain overflows China's borders.

Whatever the case may be, the raw data doesn't really support the CTANC's arguments. Indeed, most rare earth prices have fallen this year. For example, the prices of lanthanum oxide, cerium oxide, and dysprosium oxide are all down more than 40% since December 31, 2011. The CTANC doth protest too much, methinks.

China's formal response came in the form of a white paper in which it detailed stricter environmental standards for the rare earth mining industry, while still committing to uphold WTO rules. School yard squabbles notwithstanding, this makes things look very attractive for CTANC rare earth companies. The U.S. and Japan, in particular, are desperately seeking to limit their dependence on China for these highly valuable raw materials.

There was another interesting tidbit in the Chinese white paper. China claims that it sits on only 23% of planetary reserves, in contrast to the U.S.'s estimate that China holds 36%. Consider that China currently produces more than 90% of the world's rare earth supply. Further, China warned that its rare earth reserves were declining at an accelerating rate, and specifically urged the CTANCs with untapped reserves to exploit them. I recognize this could all just be a game of bait and switch. Indeed, just this week, China revealed a program to stockpile rare earth reserves, possibly to shore up declining prices. Still, it sure seems like a great time to be looking at opportunities for CTANC rare earth production.

Flogging Molly(corp)
As I've written previously, I think U.S.-based Molycorp is the most interesting company in this space. A major element (pun intended) of my interest is Molycorp's continued success in integrating its operations across the entire rare earth value chain. The company took yet another step in that direction in June, when it officially completed its acquisition of Neo Material Technologies, thereby allowing Molycorp to produce valuable magnets for the auto industry and other end users. Rare earth analysts believe this could be a genuine game-changer. It sure sounds like thar's gold in Molycorp's hills.

So, nothing could possibly go wrong, right?
There's just a teensy point of concern here. Honda (NYS: HMC) announced in June that it would start recycling rare earth elements from hybrid auto batteries this year. Toyota (NYS: TM) reported in January that it had developed a technology that would allow it to subvert the use of rare earths altogether if rare earth prices did not come down. Given the decline in prices since then, it's unclear how fully Toyota will continue to pursue this initiative.

Considering that Japan consumes about 60% of China's rare earth exports, and the fact that China petulantly cut off supply to Japan in 2010 with painful results, I can't imagine that Japanese players aren't looking to hedge their bets. Indeed, Japan is actively collaborating with other countries to exploit their rare earth reserves. On the one hand, this should be great for non-Chinese rare earth producers. On the other hand, the whole discussion could become irrelevant if Honda and Toyota get around this raw material entirely.

Forging ahead
Investors should watch to see how the WTO rules on this dispute. While largely toothless, the WTO still plays a role in shaping such global markets, and its decision in this matter will have an impact. Regardless, I expect that non-Chinese rare earth producers are about to see their day in the sun. My bet is on Molycorp, but if you are not ready to bet on a single player, consider the Market Vectors Rare Earth / Strategic Metals ETF (NYSEMKT: REMX) . This ETF has taken a clobbering in the last year, but it may benefit from the broader trends we've covered here.

If you're interested in other developments that are disrupting Chinese dominance of an economic sector, you just have to read our free report, "The Future is Made in America."

At the time thisarticle was published Fool contributorSara E. Wrightowns none of the stocks mentioned in the story above. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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