China Lights Fuse Under Rare Earth Stocks

06/21/2012 11:28 am EST

Focus: STOCKS

Thomas Aspray

, Professional Trader & Analyst

News out of China has propped up slumping rare earth stocks, which are now likely to continue 5%-10% higher, presenting short-term buy opportunities for investors who don’t mind the risk.

Rare earth metal stocks bucked the market’s trend on Wednesday by closing sharply higher on heavy volume. The news out of China sparked a rally in what has been a severely depressed market.

The Chinese government’s warning that rare earth resources in the major mining areas were already depleted was thought by some to be just an excuse to support the nation’s restriction on exports.

Certainly, those who are expecting the Chinese economy to suffer a “hard landing” have made the case that the rare earth stocks are overpriced. I have felt for several months that the Chinese government would do whatever it takes to turn the economy around, and the recent actions suggest China is starting to get serious about that initiative.

Even if there is no real shortage of rare earth elements, a resurgence in China’s economy would be positive for these stocks, which have been in a year-long bear market. The sharp increase in volume is a positive sign, and now is the time to target new buy levels.

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Chart Analysis: Molycorp Inc. (MCP) is a $2.16 billion development company that produces and sells rare earth oxides. The weekly chart (left panel) shows that MCP made a high of $79.16 in May 2010.

  • The downtrend from the 2011 highs, line a, is now in the $27 area
  • Despite the 8.5% gain on Wednesday, the weekly chart still shows a tight trading range over the past five weeks
  • The major 38.2% Fibonacci retracement resistance is at $41.90 with the 50% resistance at $49
  • Even though the volume this week has been high, the on-balance volume (OBV) is still well below its weighted moving average (WMA) and the downtrend, line b

The daily chart for MCP (right panel) shows that the upper boundary of the trading range at $22.40, line c, was tested on Wednesday.

  • There is further chart resistance from the March lows in the $24.25 area
  • Daily relative performance, or RS analysis, is trying to bottom out. It has turned up from support and is above its weighted moving average
  • OBV has completed its short-term bottom formation and moved above its weighted moving average and the resistance at line f
  • The 20-day exponential moving average (EMA) is at $21.04 with stronger support in the $19.50 area, line d

NEXT: More Rare Earth Stocks Likely to Rally

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Avalon Rare Metals Inc. (AVL) is a $168 million Canadian rare earth development and exploration company. AVL peaked at $10.11 in April 2011 and recently hit a low of $1.36.

  • There is major chart resistance now in the $2.35-$2.55 area, which is a potential upside target
  • Relative performance has turned up and moved above its weighted moving average but is still below longer-term resistance
  • Daily OBV appears to have bottomed out, as it held support (line d) and has moved above its weighted moving average
  • Volume on Wednesday was almost three times the daily average
  • The rising 20-day EMA is at $1.51 with further support in the $1.46-$1.48 area

Rare Element Resources Ltd. (REE) is a $228 million company that acquires and explores mineral assets in both Canada and the US. The stock’s rally on Wednesday broke through the daily downtrend, line e.

  • REE hit a high of $17.92 in January 2011, so the major 38.2% Fibonacci retracement resistance is now at $8.80
  • Relative performance broke its downtrend (line g) last week and has now turned up more sharply
  • The RS line has found good support at line h and has moved above its prior highs
  • Daily OBV has been holding well above its lows from late 2011 and is now above short-term resistance, line i
  • First price support is at $4.55 with the 20-day EMA at $4.37

What It Means: A turnaround in the rare earth metals could be significant for the Chinese stock market as well as some of the other emerging markets. Those who have traded these markets, however, know that they are not for the faint-hearted and are quite volatile.

There is a good chance that after Wednesday’s rally, the rare earth stocks will add another 5%-10% on the upside before they consolidate. If they instead give back a bit of their recent gains, it should provide a reasonable—but not a low-risk—entry point.

I favor Rare Element Resources Ltd. (REE) above the others, followed then by Molycorp (MCP), and would avoid Avalon Rare Metals (AVL) for now.

How to Profit: For Molycorp Inc. (MCP), go 50% long at $21.44 and 50% long at $20.66 with a stop at $19.58 (risk of approx. 7%). Cancel the order if $24.30 is hit first.

For Rare Element Resources Ltd. (REE), go 50% long at $4.54 and 50% long at $4.14 with a stop at $3.92 (risk of approx. 9.7%). Cancel the order if $6.30 is hit first.

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