Powerful Breakout May Be Setting Up in Molycorp

A confluence of factors could push shares of battered rare earth miner Molycorp MCP higher in the coming weeks. Despite only becoming a publicly traded company in 2010, Molycorp has already had a very colorful history. The Greenwood, Colorado-based rare earth oxide (REO) producer did its initial public offering on July 28, 2010 at a price of $14 per share. On its first day of trading, Molycorp fell 8.2 percent to close at $12.34. Subsequently, however, the stock soared as investors and speculators became ever more optimistic on the company's prospects amid a global shortage of rare earth minerals which triggered a sharp rise in prices. Molycorp also had the distinction of being the only REO producer in the Western hemisphere and one of the largest, most fully developed rare earth projects outside of China. The market became wildly bullish on the prospects of the sector as a whole because of the use of rare earth minerals in electronic devices that were in high demand, such as cell phones and smartphones. Rare earths are also used in a host of other industries such as clean energy, fiber optics, lasers, and hard disk drives. In its first nine months as a publicly traded company Molycorp shares jumped around 460 percent. Since that time, however, it has been all downhill for the stock as a decline in rare earth prices hammered the company's earnings. During the big run-up in both rare earth prices and Molycorp's stock price there was a global shortage of the minerals due to tight supply on the back of Chinese export restrictions. When China moved to ease these restrictions, prices began to plunge. Illegal production in China and smuggling also shifted supply/demand dynamics in the market. The result has been a spectacular decline in MCP. On April 15, 2011 the stock hit a high above $74 before the brutal sell-off commenced. The 52-week low in the name of $4.60, which was touched in April 2013, represented a decline of over 93 percent from the April 2011 highs. In recent days, however, MCP has begun showing some signs of life and a number of bullish factors could contribute to a sharp rally in the stock. On May 10, Molycorp jumped sharply after the company released its fiscal first-quarter financial results, topping Wall Street estimates. Molycorp reported an adjusted loss of $0.15 per share versus a loss of $0.18 per share in the year ago period. This topped Wall Street consensus EPS estimates calling for a loss of $0.27 per share. Revenue came in at $146 million, which also easily surpassed street expectations of $137.52 million. The company also said that it is on track to reach full-scale commercial production at its key Mountain Pass rare earth mining facility in California by mid-2013. This could be a bullish catalyst for the stock price. "Our ongoing production ramp-up at Mountain Pass remains on course, and our increasing production is allowing us to produce for end-use customers as well as provide greater feedstock to our downstream, value-added processing facilities," said CEO Constantine Karayannopoulos. The technical picture in the stock also suggests that investors are getting incrementally more positive on the name ahead of the Mountain Pass ramp-up and in the wake of better than expected results for the first-quarter. After surging in the immediate aftermath of its earnings report, MCP formed a technical pattern known as a bull-flag. This pattern is created when a stock re-traces for a period of time after staging a sharp rally. Technical traders look to buy the stock during this correction on the expectation that the initial rally will be followed by an even larger up-move. The logic behind this technical pattern is that because the stock has been beaten down so mercilessly there are a significant number of traders and investors just looking to get out. Therefore, these trapped longs will look to sell immediately after the initial rally. This causes the correction, or "flag" formation. If, however, the market is starting to recognize a fundamental shift in the company's operating outlook, which may be happening in Molycorp, this retracement won't last long as demand once again overtakes supply -- leading to an even larger breakout. On Monday, May 20, this is what happened in MCP, although traders will want to see additional follow through to confirm the breakout from the bull flag pattern. During the session, MCP jumped almost 11 percent on very heavy volume. Furthermore, prices are on the verge of breaking through a downward trendline that goes back to the beginning of 2013. If the stock continues to climb in the coming days on heavier than usual volume, the price breakout will have strong confirmation and Molycorp could be set to ride considerably higher in the near-term. Adding fuel to this potential bullish setup is the presence of large short positions in the stock. In recent weeks, around 30 percent of the company's float had been sold short. Undoubtedly, these short-sellers are watching the potential bullish set-up outlined above closely -- and they may be getting nervous. Given MCP's trajectory since the April 2011 high, the vast majority of bearish speculators are already sitting on large profits. Now that the stock is starting to show renewed signs of life, these short-sellers may be very inclined to begin covering their positions. In turn, this short-covering could provide another catalyst for a significant breakout in Molycorp if the current flag formation plays out as expected. Bullish - Molycorp's key Mountain Pass facility is expected to reach full-scale production in mid-2013. Ahead of this development, the company posted earnings and revenue results which were ahead of market expectations. This fundamental shift in Molycorp's operational outlook coincides with a potentially explosive technical set-up. The stock is heavily shorted and MCP has carved out a bullish flagging formation -- a well-known technical pattern. Furthermore, Monday's high-volume rally suggests that a number of large market players are expecting this bull flag to resolve itself in an even larger up-move. Bearish - With the exception of the recent activity in MCP, this stock has been disastrous to own since hitting highs above $74 in April 2011. The company remains a very speculative play on the rare earths sector and the recent strength in the name is hardly enough to confirm the beginning of a new uptrend. Overall, MCP's chart remains broken on a longer-term basis and a speculative long play from current levels is a risky trade.