Someone posted this good article from other board and I would like to share in here.
Mining Stock Investors Are About to Get Clobbered
Commodities /
Metals & MiningOct 31, 2010 - 03:46 PM
By: DailyWealth
Matt Badiali writes: Oh boy... the crowd is about to get killed in resource stocks again.
And this time, the Grim Reaper comes in the form of "rare earth element" stocks...
Asmy editor Brian Hunt told you last week, "'Rare earthelements' is thename of an exotic group of metals, includingstrange-sounding memberslike lanthanum and cerium. These little-knownmetals are crucialcomponents of electric car batteries, wind turbines,and advancedelectronics (the kind in your iPod or cell phone)."
Rare earthelements are the hottest thing in the miningworld right now. China holdsa virtual monopoly on the rare earthindustry. And in the past fewmonths, the Chinese have reduced theamount of rare earths they'rewilling to ship to other countries.
This has created a frenzy for the handful of rare earth element plays in the stock market.
Take Molycorp (MCP) for instance...
Molycorpcontrols the Mountain Pass mine. In the 1970s and1980s, before Chinagot in the game, the U.S. was the world's largestproducer of rareearths. A big part of that production came fromMountain Pass. The mineis shuttered now, but it remains the largestdeveloped rare earth depositin North America.
Just a few months ago, Molycorp went public at$14 pershare... It has ridden a hype wave to a 150% gain and a $3billionmarket cap.
Here's the thing: The demand for rare earthelements isn'tthat large. According to the MIT Technology Review, itwill be 125,000tons this year. The entire market is worth less than $1billion peryear. In other words, Molycorp's market cap is three timesthe size ofthe annual market of its proposed product (yes, that marketis going togrow, but it will remain relatively small).
There isanother huge problem with Molycorp... It isn'towning up to the amount ofwork required to meet its promises toshareholders. Right now, the onlyplace you can refine the rocks intopure metal is in China. Molycorp willneed to spend over $511 million tobuild the infrastructure it needs tocompete with the existing Chineseindustry.
(The company estimatesit can be in full production by2012. In my experience, most minesdevelop hiccups along the way. Fullproduction is likely to occursometime in 2013.)
Finally, the potential for loss at this stockprice ishuge... I calculated the net present value for Molycorp. This isa roughestimate of the fair value for the stock right now. It takesintoaccount assets, debt, and future cash flows. I also figured outthecompany's the value by comparables (like valuing your house bylookingat the recent deals in your neighborhood).
These two methods produced values between $570 million and $636 million.
Today, Molycorp trades for $2.94 billion. That's between 4.6 times and 5.1 times larger than its current value.
Remember,this company must spend hundreds of millions ofdollars over the nextfew years. It won't be cash flow positive for atleast three years. Itwon't even know if it can get the loans for theconstruction before nextsummer. In other words, the downside risk hereis enormous... yet thestock is priced for perfection. If bad news comes(and it comes often inmining), shares of Molycorp could fall a long,long way.
If youalready own shares, congratulations. You've made aheck of a trade. Now,it's time to tighten up your trailing stops. Don'thesitate to sell.Aggressive traders can consider shorting the stock(although it might behard to get shares to borrow).
Ifyou're on the sidelines watching the hype build andthinking abouthopping in here, you're crazy. It's much too dangerous...the assets aremuch too expensive. You'll find safer and comparablylarge returns inuranium miners right now.
Good investing,
Matt Badiali
P.S.Another dangerous signal for the rare earth complexis the introductionof a new rare earth stock ETF last week. As we'vecovered in the past,this is an ugly indicator that means a bigcorrection is around thecorner... You can read about this indicator
here.
https://www.marketoracle.co.uk/Article23925.html