Tuesday, March 13, 2012

Molycorp (MCP) - Rare Earth -- Is it the Next Oil?

MCP is trading $31.45, up 5.3% with IV30™ down 5.0% as of ~11:20am EST. The LIVEVOL® Pro Summary is below.


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Molycorp, Inc. is a rare earth oxide (REO) producer in the Western hemisphere and owns a rare earth project outside of China. The Company is in development stage. The Company focuses to be an integrated producer of rare earth products, including oxides, metals, alloys and magnets.

The rare earth industry is a contentious one – caught in a battle between China (the world’s largest natural provider) and, well, the rest of the world. Let’s start with some news today, and then work backwards a few – as MCP stock has been on a ride. Here’s a story from AP:

WASHINGTON (AP) -- The Obama administration is bringing a new trade case against China that seeks to pressure Beijing to end export restrictions on key materials used to manufacture hybrid car batteries, flat-screen televisions and other high-tech goods.

The latest action, announced Tuesday, is part of President Barack Obama's broader effort to crack down on what his administration sees as unfair trading practices by a rising economic power that have put American companies at a competitive disadvantage.

The U.S. asked the World Trade Organization to facilitate talks with China over its curtailment of exports of rare earth minerals. The U.S. is bringing the case to the WTO along with the European Union and Japan.

In Brussels, EU Trade Commissioner Karel De Gucht said China's restrictions "hurt our producers and consumers in the EU and across the world."

Source: AP -- US brings new trade case against China

See, I told you, contentious…

Let’s turn to MCP in specific and start with the Charts Tab (six months). The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

On the stock side, from a holistic point of view, we can see how MCP stock has been crushed in the last half year. In fact, although it isn’t pictured here, the annual high was over $77. On the vol side we can see how the implied has been well over 100%, but after the large drops dropped significantly – that is, as the stock found new lows, the vol reflected lower risk (of a further drop and a recovery). As of 3-8-2012, the stock closed at $25.98. But then, March 9th happened. Here’s that news:

Molycorp (NYSE: MCP ) has made its biggest move yet, announcing that it is acquiring Neo Material Technologies, a processor of rare earth minerals, for $1.3 billion. The deal will be paid for with 71.2% cash and 28.8% newly issued Molycorp stock, and the market has cheered the deal today, pushing Molycorp shares up 19%.

The company said that the deal will give it more exposure to China, the world's largest consumer of rare earth minerals, and capture even more of the company's production in finished-goods processing.

Molycorp has a history of similar moves, buying Santoku America, AS Silmet, and a stake in Boulder Wind Power in 2011. What these moves do is allow Molycorp to reduce dependence on raw rare-earth minerals prices and get exposure to the end-market demand. In the end, however, the prices for these end products will be driven by the underlying mineral price -- and prices have been falling fast.

Source: TheMotleyFool -- Molycorp's Bold Move

It’s a bit convoluted in that there are a lot of moving parts, but ultimately the market liked it to the tune of a ~19% pop. Let’s turn to the Skew Tab to examine the vols with more precision.

This is what caught my attention. Granted we’re but four trading days from expiration, but the front is elevated significantly to the back. Given the recent news, that sounds about right. Note that for all expiries the skew shape is parabolic – reflecting both downside risk and upside potential.

I took a look at the historical skew (exactly three months ago) and I found that the back months did not show the upside parabolic shape. I’ve included that chart, below.

Again, I’m focusing this time on the back (yellow and green) months and the flat(ish) upside skew relative to the chart earlier. In total, the option market reflects greater upside potential when compared to the downside risk now in MCP relative to three months ago.

Finally, let’s turn to the Options Tab.

I wrote about this one for TheStreet (OptionsProfits), so no specific trade analysis here. We can see that while the front expiry is up 14.4 vol points, the second and third expiries are down 2.8 and 4.7 vol points, respectively. I like the rare-earth story, just in general it's fascinating how economic strength is perceived (and defended) by controlling of scare commodities (see oil).

On a side note, did we really think that moving away from oil would move us away from scarce resources controlled by "dangerous" regimes (dangerous = not in US control). I hope not, because... it won't.

This is trade analysis, not a recommendation.

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