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Time to Buy Rare Earth ETFs After Molycorp's Report?

Eric Dutram

Most commodity producers have had a pretty forgettable start to 2013. Weakness in China, a strong dollar, and sluggish industrial production figures across the globe have combined to send many mineral and natural resource prices to fresh lows in the past few weeks.

While most investors have been focused in on producers of gold, silver, and industrial metals, we have also seen some wild trading in the often-overlooked rare earth metal market. This corner of the mining world, which focuses on the lanthanides on the periodic table (along with scandium and yttrium), is vital for a number of industrial uses ranging from hybrid cars and high tech consumer gadgets, to aerospace components, lasers, and magnets.

Yet despite the crucial nature of many of the commodities on this list, the prices for rare earths have been quite sluggish. Readings of rare earth metal price indexes have fallen sharply in the past few months, and almost 50% over the past year, suggesting that this volatile space has been a big loser from the slowdown in key areas and a poor commodity outlook.

Turnaround at hand?

While there has been some rough trading in the space, investors have seen a bit of a reversal in the past few days thanks to a key earnings report from Molycorp (MCP). This important miner handily beat expectations for its latest earnings release, posting a loss of 15 cents a share, well above estimates which called for a 46 cent per share loss for the firm (read What Happened to the Rare Earth Metal ETF?).

In addition to this beat, investors also keyed in on some upbeat statements from MCP’s management which suggested that better days could be ahead for not only the company, but the rare earth metal industry at large. Molycorp President and CEO stated that ‘customers appear to be working down inventories that were built up in 2011 and 2012 and we are starting to return to more normal purchasing patterns.’

This statement along with the earnings report helped to push MCP shares up by double digits in the immediate following session, and it had a similar impact on other names in the industry as well. So perhaps investors might finally be seeing the bottom in the rare earth space, at least for the short-term.

ETF Angle

If you want a broader play on the industry, it could be worth it to take a look at the only ETF targeting the market, the Market Vectors Rare Earth/Strategic Metals ETF (REMX). This fund doesn’t invest in the rare earth metals themselves but instead focuses on key miners of these strategic products, giving investors exposure to the industry via that route (see Time to Buy this Precious Metal ETF?).

Through the first four months of the year, REMX was having a pretty rough time on solid levels of volume. The ETF lost about a quarter of its value in the timeframe, marking a pretty horrendous stretch for a fund that saw relatively decent trading through much of 2012.

In the past few days though, the fund has added significantly boosted by a stronger industrial outlook, and of course MCP’s rosy forecast. Now, REMX is up over 5% in the past five days, and this includes a modest loss in the Monday trading session.

Why an ETF for Rare Earth Metals?

Some investors might think that a play on MCP alone is the way to target the industry, especially given its beat for the most recent quarter. However, this fails to take into account the longer term trends, as MCP has greatly underperformed REMX over the past one year period.

Given this and the incredibly rocky trading in the space, an ETF approach could be a better idea to at least limit the significant risks in the industry. The fund holds about two dozen companies from around the globe and it doesn’t put more than 9% in any single company, so firm specific risks are pretty much diversified away (also see Rare Earth Metal ETF Jumps on WTO Tensions).

Furthermore, the country profile for REMX suggests that there is great diversity in the holdings and this cannot be achieved by average investor on their own. For example, just about a quarter of the fund is in North American companies, with big chunks going to Australian, Japanese, and Chinese firms instead.

While this approach may help to reduce some risks, it is worth noting that the product is likely to see significant volatility as well. Large caps account for just 6% of assets, while small cap firms make up nearly 80%, so big swings should be expected (read Why I Hate Volatility ETFs and Why You Should Too).

Bottom Line

Still, for investors who believe that the rare earth metal space has bottomed, and especially after the recent MCP leadership comments, REMX is an excellent choice. The fund is likely to experience big swings no matter what happens in the future though, so make sure you have a strong stomach before betting on this volatile market in the summer months.

However, given the beaten down nature of the segment, many names could be presenting themselves as a decent value at this time. We will have to see if the rest of the space can continue the trend though, and get rare earth metals back on track heading into what looks to be a crucial stretch for the industry as it struggles to return to prominence this year.

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