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Is Molycorp "In Play?"

Shares of rare-earth miner Molycorp Inc. (NYSE: MCP) soared as much as 20% yesterday on speculation that its bargain valuation had transformed the rare-earth miner into a takeover target.

"At this point, Molycorp is definitely in play," Luisa Moreno, an analyst and rare-earth expert with Euro Pacific Capital Inc. in Toronto, told Bloomberg News. "It would be a very good target for companies that are interested in being in this space if they recognize the rare-earth space is important and they have the cash to take Molycorp and make it a real producing company."

As we'll show you in a moment, Moreno isn't the only observer who suddenly believes Molycorp is "in play" (Wall Street parlance for a company that's become a buyout candidate).  

At this point, it's little more than speculation. But if a deal were to arise, we wouldn't be surprised.

And neither would you.

In our Oct. 4 Private Briefing report ("Nine Good Reasons to Own Molycorp"), we showed you why a buyout was a very realistic possibility. Molycorp is one of the only "turn-key" rare-earth operations outside of China. Its critical Mountain Pass mine is ramping up production even as we speak. And the company has created a "value-added" venture that gives the company a "mining-to-magnets" marketing reach.

What's more, in addition to some hefty insider buying in recent months, Chile's Molibdenos y Metales SA, an existing Molycorp investor, recently spent $45 million to buy an additional 4.5 million shares at $10 each. That brought Molibdenos' stake in Molycorp to 17 million shares – or 14% of the company.

Molibdenos clearly sees profit potential. And let's face it: A 14% position would make it real easy to launch a buyout bid for the whole company.

Permanent Wealth Investor Editor Martin Hutchinson, the former global merchant banker who originally recommended Molycorp to Private Briefing subscribers back on Aug. 24, makes an even stronger overall case for the stock.

"Given Washington's failure to do anything substantive about the U.S. budget deficit, commodity plays look even better than they did (and U.S. Treasury bonds worse)," Martin told me during a morning briefing yesterday. "In this context, Molycorp looks like an excellent rebound candidate for 2013 as its Mountain Pass facility comes full on stream, and there's also the possibility of it being taken out by some aggressive Daddy Warbucks."

As Martin explained, Molycorp controls the biggest U.S. deposit of rare-earth elements, which are used for hybrid cars, smartphones, and solar-energy panels.

And while we're currently up about 8% on Martin's recommendation, Molycorp shares stuck investors with a 61% loss in 2012. As of Dec. 31, the stock was trading at almost a 20% discount to net asset value (NAV).

"Bill, everyone knows that Molycorp has issues," Martin said. "There were cost overruns and delays in California, there's an SEC investigation of its disclosure practices, and the CEO was ousted because he'd lost credibility with investors. But when you look at the company's potential, its upside as an investment, and its collection of assets … and if you also believe we're headed into an investment environment in which natural resources and other commodities are going to rise in value … well, the only conclusion you can reach is that Molycorp is one very cheap stock."

As we said, this is only speculation right now – which is probably why the stock only held about 10.1% of that 20% gain.

Even so, one of the intriguing realities about this buzz is that the list of possible suitors is quite a bit longer than you typically find.

According to Byron Capital Markets Ltd., Molycorp's low valuation – as well as the opportunity to have a "captive" supply of rare-earth resources – could make the company attractive to manufacturers like electronics giant Siemens AG (NYSE ADR: SI) or automaker Nissan Motor Co. (PINK ADR: NSANY).

We've talked a lot about how shrewd Molycorp was to buy Neo Material Technologies Inc. – now Molycorp Canada. The addition of that processing facility makes Molycorp one of the rare "vertically integrated" players in the marketplace. And it makes it possible for the company to sidestep the processing-capacity problem that will afflict so many of its would-be rivals – like Australia's Lynas Corp. Ltd. (PINK ADR: LYSDY).

Lynas has been stalled by legal protests against its processing facility in Malaysia.

Yet Molycorp shares were trading at roughly 0.8 times book value (BV) while Lynas was trading at 1.8 times BV at the end of the year.

The Molycorp Canada subsidiary recently finished construction on a next-generation, centered-neodymium-iron-boron magnets factory in Japan. The plant, a joint-venture (JV) with Daido Steel and Mitsubishi Corp., will begin production of those specialized magnets. Molycorp says a "major automotive manufacturer" has already awarded the JV a "provisional" supply agreement for a next-generation electric vehicle.

Laurence Balter of Oracle Investment Research says the stock is so cheap – and the potential upside so massive – that even a private-equity player might go after Molycorp right now. Balter listed Molycorp as one of his "best picks" for 2013, and said the upside is $50 a share – 420% above where Martin recommended it.

"If Molycorp was ever going to be taken out, it would have to be right now and not when the stock price is three times higher than it is now and the outlook is rosy," Balter told Bloomberg. "A buyer would have to act when the stock is weak, value has been destroyed, management is in a shuffle and they are about to turn a corner. It is the time for someone to come write a big check."

In a recent report that initiated coverage of Molycorp shares, Goldman Sachs Group Inc. (NYSE: GS) said the company "could have strategic appeal given its ownership of a large-scale and commercially viable rare-earths resource outside of China." The investment bank's conclusion: There's a 15% to 30% probability of a takeover.

Goldman says that Molycorp could fetch $15 a share in a takeover. That would represent a 59% premium to the stock's Dec. 31 close – and a 56% premium to the price at which Martin recommended the shares.

One final point: For all of you new subscribers, here's a point I make each time I write about this stock. We continue to believe that Molycorp has a big potential upside, and a takeover is just another potential catalyst for profit (the greater the number of possible catalysts, the better we like it). As is the case with most high-potential stocks, it's also a high-risk investment. So it's likely to be extremely volatile. If whipsaw trading makes you dizzy, it might be a stock to avoid. Position-sizing is paramount. Use stop-losses or "average in" to reduce your risk.

When I was choosing my topic for yesterday's Private Briefing, I knew I had a choice to make. Because of the way our deadlines work here – especially on holidays – I couldn't wait as late as I would've liked before I committed to a topic.

The "Fiscal Cliff" talks had stalled again, meaning it was very possible the impasse would carry over. If that continued, I wanted you to have our best insights available when you needed them most. So instead of choosing a "safe" topic, I chose to give you some insights on what to do if the talks collapsed and America went over the cliff.

As it turned out, a late-night deal was reached, making the piece moot.

Even so, I was happy with the decision. Letters like this one, from subscriber S.H. of Virginia, showed that we made the right choice.

"With regard to Private Briefing's Jan. 2 issue, the article titled "Four Ways to Beat the Fiscal Cliff," I agree that the best course of action would have been to "just go over" the cliff. The article goes on to describe a well-thought-out analysis and series of actions to take to get ready if we went over the cliff.

However, Congress passed legislation that will stall the reaction to the measures called for in the original "Fiscal Cliff."

The article did not address what actions to take under the current conditions. Should investors still take the same actions as if we had gone over the cliff? Or are there an alternate set of actions to consider, now that Congress has made things ultimately worse by forestalling the inevitable?

Thanks for your excellent publication."

Since Martin was my main source for the Wednesday Fiscal Cliff piece, I asked him to give us a quick update on his new views on this topic.

Here's what he told me.

"Bill, as I said in my analysis of Molycorp, Washington failed to act decisively or deal substantively with the country's budget problems. Needless to say, that changes some of our recommendations," Martin said. "One recommendation that doesn't change has to do with stocks. Careful stock-picking will carry the day over set-it-and-forget it indexing. Financially sound companies with solid dividends will prove to be a key to your overall returns."

With regard to U.S. Treasury bonds, Martin says the reverse of his earlier recommendation is now the path to follow.

"We'd earlier recommended that you buy the iShares Barclays 20+ Year U.S. Treasury Bond Exchange Traded Fund (NYSE: TLT) – reasoning that an upbeat outlook for America's finances would make U.S. bonds look even more attractive than the offerings of our debt-ridden counterparts overseas," Martin said. "But the reverse is now true, meaning you want to short the TLT. You see, the market will come to realize that the U.S. won't solve its budget-deficit problems until real trouble hits."

If you're looking for additional profit opportunities, Martin advises you to look abroad.

"Buy emerging markets," he said. "They will benefit from all the stimulus money sloshing around – including the new Bank of Japan stimulus. And they are better-run than the West."

Hope that answers your questions, S.H.

I'll see all of you tomorrow.

[Editor's Note: We recommend investors maintain a 25% "trailing stop" on all holdings.]

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