Sumitomo Corp <8053.T> is in talks with Molycorp on a rare earth supply deal and may take a stake in the U.S. company, the latest move by a Japanese firm to secure supplies of the crucial minerals outside China.

Japanese trading houses have been scrambling to secure new sources of rare earth -- vital for making auto parts and high-tech products -- in recent weeks after shipments from dominant producer China stalled, possibly due to diplomatic tensions or because its export quotas had run dry.

China, which produces 97 percent of the world's rare earths, set 2010 export quotas 40 percent lower than 2009 levels, raising alarm among buyer nations about supplies.

A spokesman for Sumitomo, Japan's third-biggest trading house, said various options were being discussed for a supply deal, which could lead to it taking a stake in Molycorp, but he gave no further details.

Earlier on Tuesday, the Nikkei newspaper reported that Sumitomo plans to invest 10 billion yen ($120 million) in Molycorp's expansion and is eyeing an equity stake in the company, which has a market value of about $2.3 billion.

It (the deal) meets the needs of the Japanese to diversify their sources of resources, said Tomomichi Akuta, senior economist at Mitsubishi UFJ Research and Consulting.

By taking a stake (in Molycorp), Sumitomo believes it can benefit from a rise in the value of its shares.

Sumitomo and Molycorp may reach an agreement this week and shipments will begin in spring and run through 2012, the Nikkei said.

Sumitomo plans to import nearly 2,000 tons of rare earths next year, including both new output and inventoried stock, with shipments expected to grow to 3,000 tons in 2012 -- about 10 percent of current Japanese demand, the paper said.

Sumitomo plans to import cerium, lanthanum and neodymium, among other rare earths from Molycorp, the Nikkei said.

Sumitomo Corp shares edged up 0.3 percent in a flat <.N225> Tokyo market.

Shares in Greenwood, Colorado-based Molycorp surged 18 percent to close at $32.86 on Monday in New York after the Nikkei report.

Molycorp shares have risen sharply since China lowered its export quotas. Shipments to Japan dried up in September due to longer customs inspections, prompting reports that Beijing was choking off supplies to Japan due to a spat over disputed islands in the East China Sea, sending prices of the minerals soaring. China denied it had imposed any embargo.

Mitsubishi Corp <8058.T> also said on Tuesday that one of its units had signed a one-year contract to import a portion of Molycorp's inventory, further evidence of Japanese firms rushing to diversify procurement away from China.

Last month, Sojitz Corp <2768.T> reached a deal with Australian miner Lynas Corp to secure more than 9,000 tonnes of rare earths per year -- nearly a third of its current needs -- from early 2013.

News of Sumitomo's likely investment lifted stocks in the Canadian rare earth sector, where takeover talk has been rampant.

Shares of Vancouver-based Rare Element Resources jumped more than 13 percent on Monday on speculation a deal with Sumitomo could prompt Molycorp to bid for Rare Element, which owns rare earth properties in the United States.

(Addtiional reporting by Chikako Mogi; Editing by Nathan Layne and Anshuman Daga)