Stock Quotes in this Article: TIE

WINDERMERE, Fla. (Stockpickr) -- If you’re looking for a sector that could have huge upside potential, then I would suggest that market players take a very hard look at the rare earth metals stocks.

Rare earth metals are a collection of 17 chemical elements in the periodic table, including scandium, yttrium and the 15 lanthanides. The rare earths metals market was once just a bunch of boring elements that nobody really cared about, but that has changed in a big way as its application has expanded. Rare earths metals are now used in a wide range of applications, including wind turbines, hybrid and electric cars, fuel cells, LCDs, smart bombs, nuclear reactors and lasers. Currently, China supplies over 90% of the world’s rare earth minerals.

This huge sea change has created big demand for rare earth metals from companies across the globe. Also fueling the demand will be population growth. For example, as China and India grow, their consumers will want more luxuries items that use rare earth metals.

Just this morning, China announced that it plans to raise export taxes for some rare earth metals by 25% next year. This move by China is seen as an attempt to apply the same tax standard across the entire rare earth metals market. Most analysts don’t think this will affect the pricing or demand for the metals. In fact, most companies that are end users of rare earth metals will simply pass along the costs to consumers.

----------------------------------------------------------

More From Stockpickr

  • Base Metals Stock Winners
  • Top-Rated Metals & Mining Stocks
  • 7 Stocks to Benefit From Higher Oil Prices
  • ----------------------------------------------------------

    Some market observers are concerned that China is going to cut exports and use its rare earth metals supplies for its own projects. This has been true to an extent, but I think that at the end of the day, China will succumb to market demands and realize that there’s too much money to be made to shut the entire world out. Also, producers are going to find new supplies and ramp up production in other parts of the world that are friendlier to the global markets for rare earth metals.

    According to a recent report out of the Energy Department, it currently takes seven to 10 years to obtain permission to open a new mine in the U.S., which is the longest wait time among the top 25 mining countries. Look for this to change rapidly as the U.S. and other nations realize that they must begin new mining projects so they’re not held hostage by China. Western nations aren’t going to deal with supply disruptions from China for long because they know these key elements are used in too many important markets.

    As an investor, the short-term supply disruptions out of China (exports were cut by 72% in the second half of this year) just make the sector that much more attractive. Prices can only go up when supply is limited, which will lead to higher stock prices. And as I said above, I think this is a short-term problem and that China will change its ways.

    Even if China doesn’t change, my take is that free market capitalism will lead to solutions to supply problems. Regulators will adjust, companies will start new projects, and mergers and acquisitions will hit the space to exploit the problems. I would even expect to see large mining companies such as Freeport-McMoRan Copper & Gold (FCX), BHP Billiton (BHP) and Rio Tinto (RIO) move into the space to capitalize on this new gold rush.

    With this in mind, here's a look at a number of rare earth metals stocks that could have big upside potential.

    The easiest way to play the rare earth metals market is with the recently launched Market Vectors Rare Earth Metals ETF (REMX), which will give market players a broad range of diversification among a number of companies that operate in the space. One of the best parts about this ETF is that it provides decent liquidity for investors. Since the REMX launched in late October, it has averaged about 445,000 shares traded on a daily basis. That amount of share volume is more than enough liquidity for the average investor to move in and out of this ETF.

    What’s even better than the liquidity with this ETF is that the fund is so fresh and new that investors can still get in on the ground floor. Since the REMX hit the market, this ETF has traded within a range of $19.25 to $22 a share. I would suggest that market players look to buy this ETF on any weakness and position themselves for the future major bull market in rare earth metals. Any pullback under $20 should be considered a gift as long as the REMX doesn’t take out its low of $19.25.

    Another strategy investors can deploy to play the REs market is to look at the top holdings in the REMX that are U.S.-based and piggy back the fund by playing those names. Two names I would consider for this strategy are the fund's top U.S.-based holdings: Titanium Metals (TIE), which is the fifth-largest holding in the fund at 5.5% of total assets, and RTI International Metals (RTI), the 10th-largest holding in the fund at 4.5% of total assets. These two REs plays are the top U.S.-based holdings in the fund.

    Titanium Metals, a producer of titanium melted and mill products, is my favorite play off this strategy The stock has recently seen some very healthy insider buying totaling around $2.5 million. It’s also worth noting that TIE has $221 million of cash on its balance sheet with no debt. We could have an acquisition target here as well, since TIE has a market cap of only $3 billion.

    Another rare earth metals play that could reap huge rewards for market players is Molycorp (MCP), a rare earth oxide producer in the Western Hemisphere that owns the most fully developed rare earth metals project outside of China. Molycorp has put in one heck of a year, with shares up an eye-popping 268%. My take is that those gains are still in the early stages if the rare earths metals market continues to be a big winner.

    The market cap for Molycorp is around $3 billion, and the enterprise value is $2.7 billion. The company just obtained some additional financing for a new mining project that should now fully fund that development. Molycorp also has a strong balance sheet, with around $351 million of cash on the books and only around $5 million in total debt.

    From a technical standpoint, market players should watch MCP for a potential breakout play if the stock can manage to trade above some previous overhead resistance at around $38 to $41 a share. If MCP can clear these levels, then the stock would be entering new all-time-high territory. I would consider a big-volume move above those resistance areas as extremely bullish for the future of this stock. Look for volume that comes in above the three-month average trading action of around 3 million shares on any breakout.

    If this does happen, I think this stock could begin to send the short-sellers in the name running for the exits. Currently, the short interest as a percentage of the float for MCP stands at a rather large 14.8%. If this stock does break out, this high short interest is going to fuel a massive short squeeze since the tradable float for MCP is only 27 million shares.

    Another interesting play on the rare earths metals market is Rare Elements Resources (REE), which is engaged in the acquisition, exploration and development of mineral properties primarily in Canada and the U.S. Rare Elements has also had a great year, with shares up over 200% so far in 2010. I think the huge gains for REE are just beginning since this company is one of the smaller players in the space with plenty of room to grow.

    Rare Elements has a market cap of $339 million and an enterprise value of $326 million. The company has about $11 million of cash on its balance sheet and no debt. What a like about those figures is that Rare Elements is small enough that a larger player who wants to enter the rare earths metals market could easily see this stock as a sweet takeover target. Even if a major player paid twice the market cap for this stock, it would still come in at under $1 billion. That’s nothing to a company like Rio Tinto, which has market cap of $135 billion.

    Oh, and don’t let the naysayers try to tell you that this stock isn’t a legitimate player in the rare earths metals market. Currently, REE is the 18th-largest holding in the Market Vectors Rare Earth Metals ETF, making up 2.71% of total net assets of the fund. If this company wasn’t a true player, I highly doubt it would’ve been included in the ETF.

    From a technical standpoint, REE has some solid support in the low $9s. Watch for a move above the 50-day moving average at around $10 a share for confirmation that this stock is gearing up for another run higher. If it can break above some previous overhead resistance at around $12 a share, then I would watch for a move back towards the highs around $14.

    To see more rare earth metals stocks, including Great Western Minerals Group (GWG) and General Moly (GMO), check out the Rare Earth Metals Stock Plays portfolio on Stockpickr.

    -- Written by Roberto Pedone in Winderemere, Fla.

    RELATED LINKS:

    >>3 Dividend Stocks With Lots of Cash, No Debt
    >>Tax-Selling Bargain Stocks

    >>4 Sin Stocks the Vice Fund Is Betting On

    Follow Stockpickr on Twitter and become a fan on Facebook.

    At the time of publication, author had no positions in stocks mentioned.

    Roberto Pedone, based out of Windermere, Fla., is an independent trader who focuses on stocks, options, futures, commodities and currencies. He is also an outside contributor to Beconequity.com and maintains the website Maddmoney.net, which he sold to Blue Wave Advisors in 2008. Roberto studied International Business at The Milwaukee School of Engineering, and he spent a year overseas studying business in Lubeck, Germany.